Sector Foresight - The UK leisure market
Running to stand still
KPMG’s analysis of the activity within the UK leisure market points to an overall situation of operators continuing to struggle with maintaining margins in a continually tough market. On the positive side, there appear to be few shocks in store for operators and lenders provided the former continue to manage competitively and the latter closely scrutinise the operating performance of businesses they lend to.
- £66bn leisure industry in 2011 has dropped from high of £70bn in 2007 – analysts expect a further dip in 2012
- Leisure employs an estimated 1.8 million people - nearly 10% of UK total employment
- Fifth largest industry in the UK in terms of GVA
The UK leisure market includes pubs, restaurants, clubs and related venues such as cinemas and bowling alleys as well as health clubs. The estimated value of the market in 2011 is around £66 billion – down £4 billion since 2007 and start of the economic downturn. In real terms, with the effects of inflation removed, the decline in the value of the market is even greater, at 22% between 2006 and 2011. During that period, although interest rates have remained relatively stable, so have earnings. Given that the most recent period has seen inflation-fuelled cost increases and that unemployment is likely to rise further in the near future, the prospects for a sector reliant on discretionary spending are unlikely to be rosy.
Although the reported operating performance across this diverse market varies by market segment, there are several unifying characteristics. Many operators are witnessing changes to the pattern of spending by consumers. Although there is an increased tendency for customers to seek out discounts, offers and bargains, spending on leisure activities such as eating and drinking continues as an integral part of everyday lifestyles rather than being regarded as a luxury or discretionary purchase. There are demographic and segmental changes to the frequency of spend and the choices made by consumers, but the underlying trend is one of apparent stability for most segments. With this as a backdrop there appears to be little appetite on the part of major operators to enter into significant M&A activity – not least because growth prospects across the market are limited. Equally, there is little evidence of much distress across the market, with few businesses going under despite the prevalent tough economic conditions.
Pub operators are looking to maximise returns from all aspects of operations and to increase overall revenue against a rising cost base (increasing business rates, wages, utility costs, etc) and significant tax impacts. Relative volumes of trade have decreased and there is a general increase in ‘at home’ drinking and socialising. Despite these pressures, the segment appears to have stabilised, with most of the weaker businesses having fallen by the wayside already. However, as a caveat to that, ‘on-trade’ drinking is in decline with more consumers drinking at home and drinking low to moderate levels in pubs.
For some operators there is a background issue of having to service relatively high levels of debt; however, most of this is in the form of securitised loans and bonds and therefore relatively efficient forms of leverage. There will continue to be issues arising from poor loan-to-value ratios for operations using property for security and continued reliance on tied contracts with major brewers to increase cash flow and optimise costs. Although the demographics of each pub’s territory typically override other factors, the specific efforts made by local pub managers to achieve a differentiating focus are also a key determinant of whether revenue will increase, decrease or plateau.
The restaurant segment has been negatively affected but it is a tale of two halves and two geographic locations. Although some consumers are down-trading to save money, the overall trend suggests would-be diners are looking for better value from their dining experiences and are increasingly less tolerant of poor quality product or service. Despite a recent downturn, spend in this segment does continue and restaurateurs can forecast trade with some certainty – particularly the familiar, branded chains.
To combat fluctuations in trade, operators are relying on discounting, including the issue and redemption of vouchers (Groupon and variants of the same) which, although not favoured by the industry, prove difficult to relinquish. 40% of consumers now make a restaurant choice based on offers/discounts available. Again, there is evidence that ‘at home’ dining has eroded the frequency of restaurant visits, but this has had more impact on the fortunes of smaller, independent operators than larger chains and on regional business rather than within the M25 and South East. Larger, familiar brands which can establish an emotional connection with the diner are expected to do better.
In terms of overall business performance, growth is hard to come by, but the segment is comparatively stable by retail standards. Gearing levels are typically lower within the restaurant segment than the pub segment and therefore there is less P&L pressure to service debt. However, some operators may find it difficult to raise capex funding for refurbishments over the coming months. Those that can will be able to invest in improvements which may result in improved competitiveness through improved facilities, but those unable to source such funding will lose out.
Health & fitness centres
Health and fitness centres are finding it hard to increase membership numbers. Capital investment for refurbishment and to invest in cutting edge gym technology is hard to come by. Although there has been an increase in value over the past five years, this increase is largely down to improved yields per member and could prove unsustainable without ongoing investment. At the luxury end of this market there has been a significant squeezing of revenue, some consolidation and the overall outlook for the segment remains subdued.
There are regional differences apparent here too, with London-centric sites outperforming other regions, particularly the North, which is struggling. However, the squeeze in consumer spending has highlighted a potential opportunity; there are only around 70 budget clubs in the UK out of over 2,500 and with consumers citing cost as the key reason for not joining a gym, this suggests growth potential at the bottom end of the market. However, sourcing capital investment to start an enterprise is tough.
Cinemas have fared relatively well with admissions continuing to grow year on year (UK admissions were up 1.4 per cent in 2011 against 2010 at of 171.5 million) and continuing with a strong start at the box office to this year. The strong start to this year is in contrast the very poor trading last year over Easter, when great weather and the Royal Wedding had a very significant adverse impact during one of the sector’s key trading periods.
Operators are now coming under increasing pressure to ensure all their screens are converted to digital with some of the larger film distributors in the US already having indicated timetables for ending general circulation of 35mm films in the US. Although switching to digital brings the opportunity to upgrade to 3D as well as obtain some cost savings, there is still a substantial investment required. Several methods of meeting the cost of that conversion are being found in the market, all of which incorporate to some extent the Virtual Print Fees, and range from in-house, manufacturer based or third party led solutions.
Expected admissions over the key summer trading period is expected to be adversely impacted by the 2012 Olympics, with much uncertainty around the extent of that impact. Beyond this summer’s trading, future challenges for operators will be around getting smarter about their customers (smarter use of social and mobile technology as well as loyalty schemes to drive more targeted promotion and grow concessionary spend), looking for expansion opportunities while the construction sector remains depressed, and financing the refurbishment of the more tired “first generation” venues before competition from new entrants arrives in their locality.
Bowling initially rode the recession fairly well as it was seen as a cheap form of entertainment. However, leisure facilities historically reliant on narrow demographic groups, such as bowling alleys targeting the discretionary spend of teenagers or those paying for children’s parties, have suffered falling revenues in line with both general reductions in discretionary spend and a switch to healthier and cheaper pursuits. The bowling market in particular has contracted by 17% over the past five years, which equates to a reduction of 33.3% in real terms once inflation has been discounted.
For those operators who took on rents and other financial commitments which seemed realistic in 2006 are now feeling the squeeze as consumer spend drops and their cost base rises. Again, larger chains should perform better but only where location, costs and incentives have all been considered.
Jane Moriarty, restructuring partner comments “I have just helped Bowlplex agree a CVA with its landlords and other key stakeholders which will now enable its management team to really focus on driving financial performance. This interesting development shows that a CVA, a tool used widely in retail, can be just as effective in leisure. The business is currently outperforming budget “
There are around 1,600 nightclubs in the UK and that grows to 2,500 when hybrid offerings such as bars/clubs with dance floors are added but most of these are single site facilities. Nightclubs have already had a raft of issues to face including the smoking ban, recession, high youth unemployment and changes in consumer behaviour including the increased trend for ‘pre-loading’ (drinking at home before visiting pubs or clubs).
Some multiple sites in good locations with strong catchment areas, perhaps near a university, are doing steady business. But the key demographic, the 18-24 year-old, continues to feel the squeeze with higher unemployment than any other age group and with student loans stretching cash to the limit. A recent slight decline in the market is expected to continue as again, sites are hit with a double blow, a poorer, more discerning consumer and a rise in business costs.
Hotel performance rallied a little in 2011 with REvPAR (Revenue per available room) growing in London by 8.4% and the regions by 1.5%. Whilst this trend is expected to continue this year, 2013 might to see a depressed post-Olympic period, particularly for London. This year will be interesting for the budget sector in London as it will have to face the dual challenge of reduced demand and additional capacity as it absorbs the 24,000 new budget hotel rooms added in the capital over the last 3 years.
Overall the sector appears rather static and there will continue to be danger at the margins. In an economic environment with negligible growth, businesses need to take turnover from others to survive. According to Jane Moriarty: “For those operators operating at or near to the envelope for survival, competitive pressure could tip a surviving business into distress. Likewise, if management quality or focus is below that of the competition then income and margins could dip, creating financial uncertainty leading to an inability to service debt as it falls due.”
Lenders need to pay close attention to the day-to-day performance of leisure business customers – particularly those whose fortunes are sensitive to small percentage changes in the economic environment, eg interest rates and inflation. Those businesses which have enough headroom, due to having had robust checks and balances in place to spot the early signs of performance drop-off, and those with agile leadership, will provide more comfort to lenders than businesses with fragile balance sheets and inferior management processes and practices. If the economic outlook remains shaky, this approach to portfolio management for lenders may need to be in place for a further three to four years until some excitement returns to the market and consumer spend increases.
The challenges to the UK economy are forecast to remain for the foreseeable future, meaning the war for the discretionary consumer pound will continue. Justin Zatouroff, head of KPMG’s travel, leisure and tourism group comments: “While it is accepted that a base level of consumer expenditure on leisure is now part of the fabric of everyday life, the game is to wrest that spend away from other potential providers. With little organic growth for the economy in sight, the future for leisure businesses is likely to remain tough but stable and largely unexciting in terms of the potential to implement grand visions and pursue acquisition strategies.”
Those businesses within the M25 area will continue to outperform and have access to easier finance than their regional counterparts, but will still find the going hard work; much of the London and Home Counties advantage will be dependent on the ability of European travellers to spend.
On the whole, landmark events such as the Olympic Games, the jubilee celebrations and Euro 2012 will provide additional leisure traffic to pubs and restaurants, but the bounce effect from these events is not expected to change the underlying trend significantly and, in the case of the Olympics, business owners are concerned that the logistical hangover may actually impair business outturns.
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KPMG’s own analysis
Mintel Eating out: The Decision Making Process, December 2011
Mintel Leisure Review UK, December 2011