Catering in the UK has been rocked by the collapse of numerous high-profile chains over the last six months, and many asset finance providers are exercising caution over the sector. Christopher Marchant speaks to funders and brokers about how rigorous risk assessment can keep this predominantly soft asset sector profitable in times of economic uncertainty.
Earlier this year the catering sector was rocked by the collapses or financial difficulties of notable restaurant chains, including Jamie’s Italian, Byron, Carluccio’s and Gourmet Burger Kitchen.
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Analysis by accountancy firm Price Bailey showed that 1,123 restaurants closed between January and September 2018, more than in the entirety of 2017.
That so many restaurants are closing is attached to the fact that there were so many new establishments opening in the first place. “There are just too many restaurants out there,” according to Peter Harden, compiler of a guide to London restaurants.
There were also a record number of independent restaurant closures in the capital in the year to September 2018. Yet it is certainly not all doom and gloom in the catering finance sector.
Advantages for financing equipment include the relative lack of competition from banks struggling to catch up with a rise in demand for funding, a general increase in the number of people eating out at restaurants, and the commonality plus necessity for leased equipment to maintain a business.
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By GlobalDataThis relative boon, coupled with increased instability, requires careful underwriting and assessment. “If there are 10 Italian restaurants on one high street, they can’t all succeed. This means, as a lender, you’ve got to really make sure the people behind the business know what they’re doing,” explains Michaela Dodd, general manager at Academy Leasing, a 1pm subsidiary that deals extensively in the catering equipment market.
Some banks and lenders are pulling out of the catering sector entirely, regarding it as too high a risk with too little a return, adds Dodd. However, for Vincenzo Scalzone, head of broker asset finance at Hampshire Trust Bank (HTB), this is a promising sector that warrants greater involvement. “At HTB, the catering equipment sector wasn’t really something we were focusing on up until a few months ago,” he says.
“Since I’ve been in this role, we have massively diversified the asset mix and lately we are funding 20-25% of soft assets every month. “What we are predicting is that the catering industry is going to grow at a rate of over 5% from now to 2025. The restaurant hospitality sector is going to invest more in equipment as well. When we talk to brokers and suppliers, we see that they are confident about the changes that the sector is going through. They see this as an opportunity.”
John Barter is managing director of brokerage Oak Leasing, which focuses on the concept of simplicity in communication as essential to SME lending, which can help identify with the customer what they want to achieve with catering leasing.
“It’s easier to add equipment to a restaurant than it is to take it away. If it’s a new restaurant and they want £40,000-£50,000, I have the experience to know they may actually only need £20,000 to get the restaurant up and running. Too many people think they need it all now, and that is when it can fall flat for a new restaurant.”
While a figure such as Barter is primarily focused on SMEs, Hitachi Capital UK’s focus extends to supplying catering equipment to chains such as Subway, GDK (German Doner Kebab), Cafe2U and Esquires Coffee.
In June 2018, Hitachi broadened its reach in the franchising industry with the acquisition of specialist financial services provider Franchise Finance.
Gavin Wraith-Carter, managing director at Hitachi Capital Business Finance, outlines the approach to catering and why asset finance providers can find themselves in an
advantageous position: “Hitachi’s division of Franchise Finance operates extensively in the catering arena and ensures that they work closely with the supplier to guarantee payment deadlines or stage payments are met and installation programmes agreed. Suppliers themselves are keen to work with funders, as they know that with a signed finance agreement, they will be paid quickly on delivery of the asset.”
Giving her own assessment of providing for the catering industry, in the context of the overall UK economy, Dodd says: “As with any sector there is always risk involved. You need to mitigate your risk at the point of underwriting, and be aware of what’s happening in the market.
“The catering and hospitality sectors are always at high risk if there’s any kind of economic uncertainty. If there’s a tightening of purse strings it’s those sectors that do tend to feel it.
“Someone might go out two or three times a week to eat until rent and bills rise, and then decide to go out once a week to eat. The loss of those two nights a week, where people are no longer going out, has a massive effect on the catering industry.”
The appeals of catering finance in the sector can be simple, in ways applicable to a wider arena of proving finance to retail businesses. Wraith-Carter poses the question: “You wouldn’t pay a restaurant employee’s salary five years up front with the belief they will ultimately generate income for you, so why do the same with an asset?”
Catering has a very limited used market, and Scalzone explains how this aspect of the sector shapes the HTB position.
He says: “Our approach is to look at equipment as something that doesn’t really hold its value, although there are professionals that can repossess, refurbish and resell that equipment for a fraction of the original price.
“We look at catering equipment as a soft asset, therefore, from an underwriting viewpoint, customers need to be assessed on the basis of guarantees or balance-sheet lending.”
For Wraith-Carter, residual value is also closely related to the specific type and use of equipment. “There tends to be a steep depreciation at the start of an equipment lease, which does flatten out,” he notes.
“The residual value also depends on the equipment itself; for instance, extraction units are harder to resell compared to a commercial range cooker.”
Scalzone also identifies a relatively overlooked area of catering where equipment can hold greater residual value. “Restaurants and hotels are the visible part of the industry but there is another part, the food franchises and food processing manufacturing facilities. They buy more sophisticated catering equipment which has more of a lifespan past the five-year leasing period,” he explains.
Underwriting is a key factor of a turbulent market dependent on soft assets with a limited reliable resale value. With these factors, it is also inevitable that forbearance has to be considered carefully. “If the restaurant stops paying, but we know from a set time period onwards income will improve, we can look at rescheduling agreements; we call this a ‘payment holiday’,” says Dodd.
“Some businesses have the foresight and they know that they’re a seasonal business. If this is the case, we can look at a few different payment plans. Instead of a set figure every month every three years, if they depend on tourist trade they might pay maximum over summer months and lower payments out of season.”
Scalzone at HTB understands that figures are paramount in the industry. “We’ll look at the balance sheet, the cash flow the business is generating. Cash is king, but we also want to look at how strong the company is becoming over time,” he says.
“If you have a start-up restaurant which is showing very good cash-flow generation, you can’t do that deal without a strong guarantee because it is still a startup. We have to be stringent. Our view always has to be that if the worst comes to the worst you’re not going to get your money back like you would if it was a vehicle or property or other brand of machinery equipment.”
Dodd provides an example of how a lack of a used market also makes the underwriting assessment of potential customers ever more critical.
“If you look at the lower end, let’s say you’ve leased a pizza oven to a takeaway shop and they default. The chance of going in and getting that pizza oven in a condition where it can be resold as second-hand is very slim. It’s not like a hard asset underwrite where you Vincenzo think about it as a residual second-hand item that you can sell.”
Dodd also echoes Scalzone’s position that SMEs typically require more attention than larger restaurant chains. “When you’re looking at a larger business, we don’t have to do as in-depth an underwrite as you wouldn’t necessarily look in detail at the directors behind it,” she explains.
“When you’re underwriting a small independent restaurant – only a few years old or brand new – you’d want to have a look at who the directors are; you’d want to know what their industry experience is. It’s vitally important that they’ve got some kind of investment plan.
“It’s also worth looking at their affordability: are they basing this investment on 70% utilisation, six days a week? If that’s the case, there’s going to be a problem. Very few restaurants have this, and you would rather they had calculated the affordability on conservative figures.”
Equally keen to avoid the funding of a restaurant that cannot meet its obligations is a brokerage such as Oak Leasing. Explaining its approach, Barter says: “Key to funding assessments is to look at the experience of the potential customer. You look at how they got into their position and, most critically, whether they have cash reserves.
“The primary reason restaurants go under is that they don’t have a rainy-day fund. We’re not looking for customers that live on the edge, we’re seeking out those restaurants that can survive adverse periods thanks to effective forward planning.”
All the interviewees expressed a belief that the peak in restaurant numbers was not necessarily attached to one particular cuisine. “From the restaurant side there are more takeaways, but they come and go. Years ago there was a fashion for Italian, and that went out, and then it was Greek. There doesn’t seem to be a general trend now,” notes Barter.
His perception is backed by data from the 2018 Pulse report by Nisbets, a large UK supplier of catering equipment. Its survey of catering businesses ranked no single type of restaurant significantly higher than its competitors; health food scored the highest among respondents, but with only 25% identifying its popularity.
Even with a lack of specific trends, seasonal events have had a significant impact on the catering business – something which equipment leasing companies ensure they are aware of. “Catering industry professions had a great summer, thanks to good weather and large events like the 2018 World Cup,” explains Scalzone.
“The World Cup not only helped restaurants with their revenues, but it was an event that pushed them to buy new equipment. Before the event, a lot of pubs had to rent or lease IT equipment and screens to show the games.”
Also identified in the Nisbets survey was that 52% of restaurant respondents were having difficulty recruiting staff. Asked how many EU nationals were applying for positions, 14% noticed a decrease while only 2% an increase.
The impact of the UK leaving the EU is affecting both restaurant owners and equipment providers. Of this “pending doom”, Dodd says: “Brexit will have an impact, mainly because of panic and uncertainty. In one sitting you can be presented with the most contradictory statistics about what small businesses are doing.
“From a repayment point of view, you’re looking most closely at the small restaurants
that are lifestyle businesses. If the interest rates go up again, their residential rent goes up by hundreds of pounds a month, and their mortgage, and then their rent goes up on the business property. All of a sudden their ability to repay is massively impacted, and that’s where it comes back to how good your underwrite was.”
For Scalzone, it is the uncertainty surrounding the UK’s existence outside the EU that is currently affecting catering equipment leasing. “It’s important to support the industry and come up with solutions in order to help new entrants setting up,” he states.
“However, everything depends on how the economy is going to be in the next six to 12 months, in particular what is going to happen to the economy following Brexit.”
Barter takes a wider view of the economic concerns affecting the catering industry. “Businesses thrive on certainty; with uncertainty, the brakes go on,” he explains. “When approaching funders, we’ve noticed a greater degree of caution. As well as Brexit, we’re all aware of the high-profile restaurant chain failures, and those can make people nervous.”
People are always going to eat out, and as such there is always going to be room for a strong restaurant and hospitality sector in the UK.
The important questions do not arise from this area’s survival, but from whether economic conditions will contribute to an ongoing correction in the market, or whether there be signs of recovery over the next 12 months.
The provision of equipment financing still looks to find assurance in consistency and underwriting as ever, paired with hopes of rises in restaurateurs’ fortunes.
