Shares of city centre bar chain Revolution Bars Group (LSE: RBG) fell by more than 10% in early trade on Thursday, after the company warned that profits would fall below expectations.
Despite this disappointment, I believe this out-of-favour chain of trendy bars could still be a compelling buy for value investors. Here, I'll examine the issues and give my verdict on this stock.
I'll also consider a 7%-yield consumer stock that could be worth a closer look.
More excuses - what's gone wrong?
In a trading update this morning, Revolution Bars complained of "challenging and volatile trading conditions" during the half-year to 9 June. Although new openings lifted total sales by 7.3%, like-for-like sales were 1.7% lower. This suggests that sales at some older bars are falling.
Unusually, the company managed to blame both cold weather and hot weather for lower levels of "late-night week-end trading". But sites with outdoor seating areas are said to have performed well during the recent hot weather. So the problem may be that customers chose pubs with beer gardens instead of stuffy indoor venues.
Management also believe that the "prolonged absence of a CEO" and the distraction caused by last year's two failed takeover bids have also contributed to the poor performance.
The good news is that Rev Bar's aptly-named new chief executive, Rob Pitcher, is due to start work on 25 June. And the company is already moving ahead with other operational improvements. A new staff scheduling system has been rolled out and improvements are planned to marketing and to the group's underperforming food business.
New profit guidance
Adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) are now expected to be below market expectations and in line with last year's figure of £15.1m.
What does this mean for the stock's valuation? Well, last year's adjusted EBITDA translated into adjusted earnings of 14.2p per share. The last-seen share price of 139p puts the stock on a forecast P/E of about 10 for the year ending 1 July.
The group has very little debt, so I'd imagine that the forecast dividend will be left unchanged, at 5.2p. This gives the stock a prospective yield of around 3.8%, which is reasonably high for a small-cap growth stock.
What could go wrong?
It's always important to consider what could go wrong when buying a stock. In this case I can see several potential problems.
The first is that this profit warning may not be the firm's last. Like-for-like sales only rose by 0.4% during the first half of the year and by 1.5% last year. These figures suggest to me that when you consider the effect of inflation, LFL sales volumes were flat at best last year and may already have been falling during the first half of the current year.
Although food sales should offer potential for growth, a number of casual dining chains are suffering from over-expansion at the moment. Pubs chains offering food have admitted that conditions are very competitive. Can Revolution Bars really outperform in such an environment?
The group's decision to continue rolling out new bars has meant that although underlying cash flow is quite good, the company has needed to borrow cash to afford both capital expenditure and dividend payments. Arguably this means the dividend is being funded with borrowed cash. Given that net debt was just £4.5m at the end of the first half, I'm not too concerned about this yet. But I would be concerned if net debt continues to rise.
Buy, sell or hold?
Revolution Bars' rollout has been promising, but hasn't quite delivered on expectations. However, the firm is taking steps to correct problems and address areas where it's underperforming.
Incoming chief executive Pitcher has 25 years' experience in the hospitality sector. His previous role was as a divisional director at pub group Mitchells & Butlers, where he was responsible for food-led brands Toby Carvery, Harvester and Stonehouse.
Revolution's bars focus on premium drinks, so are heavily dependent on consumer spending remaining strong. A recession could hit the group hard. But if the economy remains stable, my view is that this company does offer a potential buying opportunity.
After all, it wasn't long ago that Revolution received a cash bid worth 203p per share. With the shares trading at around 140p, I'd rate the stock as a speculative turnaround buy.
A retailer with a 7% yield
Another stock that's performed well during this long period of cheap credit and low unemployment is furnishings and floorings retailer ScS Group (LSE: SCS). Even more than Revolution Bars, this is an extremely cyclical business. Sales could collapse if cheap credit dries up or if the economy goes into recession.
For now, trading remains fairly good. Revenue rose by 4.9% to £333m last year while earnings rose by about 8% to 23.5p per share. Analysts expect the firm to report revenue growth of about 5% and earnings growth of around 2% for the current year, which ends on 29 July. On 21 March, management confirmed that trading for the year to date was in-line with expectations.
The company ended last year with net cash of £40m and no debt. Although some of this cash represents advance payments from customers, the group's net cash position suggests to me that it could survive a downturn in sales more easily than rival DFS Furniture, which has substantial borrowings.
The group's strong cash generation and lack of debt also means it's able to pay generous dividends. This year's forecast payout of 15.9p per share represents a forward dividend yield of 7%.
One to buy?
Like Revolution Bars, I believe ScS should continue to do well if the UK economy remains stable. I don't have a strong view on the outlook for the economy, but I'd rate this stock as one of the more attractive options in this sector.
If you're looking for a high-yield income stock with some growth potential, ScS could be worth considering.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.