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Is this small-cap a contrarian buy or one to avoid? Here’s what I think

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The Restaurant Group (LSE:RTN) operates a diverse group of restaurant brands. Despite the impact of Covid-19, could this restaurant group be a contrarian buy for your portfolio? Restrictions have eased, but it’s certainly not smooth sailing for the industry. I decided to investigate further.

Opportunity or one to avoid?

The Restaurant Group operates many popular restaurants you will have heard of and probably dined in. These include Wagamama, Frankie and Benny’s, Chiquito, and Garfunkel’s Restaurant. RTN has over 650 restaurants across the UK as well as 70 concessions outlets, most of which are in UK airports.

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The restaurant and bar trade has been battered by the economic downturn and market crash. Back in May, Bella Italia owner, The Casual Dining Group, plunged into administration. There have been well-documented issues with JD Wetherspoons and many others in the beleaguered industry. 

RTN saw its share price drop from 133p per share to a lowly 23p between 18 February and 18 March. This equates to a mammoth 82% decrease. At the time of writing, shares can be purchased at close to 55p a piece. This is a dirt cheap price but still, cheap prices do not always equate to value for money. The old adage, ‘you get what you pay for,’ springs to mind. A contrarian buy is probably not on the cards here.

Recent activity

In the downturn, RTN took steps to remain operational and weather the storm. At the height of the lockdown, it decided to slash costs by scrapping capital expenditures as well as raising close to £60m. These much needed funds strengthened a weakening balance sheet. The money was raised through a share placing as well as increasing revolving credit facilities (RCF).

Additionally, an update in July confirmed further reliance on its RCF, which added £10m of debt to the books. The government scheme to support with jobs has been utilised too, which is not a positive sign in my opinion, but necessary for many businesses such as RTN.

Approximately 60% of RTN’s restaurants are open at the moment, with a target of 90% open by the end of September. The Eat Out to Help Out  scheme will boost sales but the next trading update will tell us whether the impact is significant or not.

Better contrarian buys out there

Overall I am not convinced regarding RTN as an investment. It has relied heavily on government support and has increased debt levels to keep the lights on. I understand there will be pent-up demand for restaurants as restrictions continue to ease. For me, this is not enough to return the hospitality sector to its former glory.

The sector as a whole will experience demand, but with increasing costs and lower demand, the omens are not good. This is best portrayed by RTN’s full-year results prior to the downturn. 2019 was a loss-making year for RTN.

In my opinion there are better contrarian buys out there. I would stay away from hospitality stocks right now and veer towards fast-moving consumer goods and technology stocks. My Foolish colleague details how to be a good contrarian investor.

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Jabran Khan 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.

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