Should Tesco PLC Mop Up Restaurant Chains In The UK?

tesco2“Tesco Restaurants”: how does it sound?

Now you think I am completely out of my mind. Well, maybe I am — but I haven’t lost the plot. New Tesco (LSE: TSCO) CEO Dave Lewis needs a brand-new strategy, so here is a bold plan for a man who knows well the dynamics of the supply chain. That’s precisely where value may reside if Tesco decided to snap up restaurant chains in the UK.

Look at the fundamentals of one possible target, Domino’s Pizza (LSE: DOM). Like-for-like sales are growing fast. Its operating profit margin is forecast at 15% to 20% to the end of 2016, while the net income margin is expected to rise above 10%. At Tesco, divestments of unprofitable assets could easily fund bolt-on deals. Restaurant Group (LSE: RTN), Tasty (LSE: TAST) and Prezzo (LSE: PRZ) are also attractive.

Domino’s Pizza: A Small Bite

Domino reported a trading update on Thursday that made for a good reading. Q3 like-for-like sales rose by 12.9%. Tesco could do with that.

Domino has been growing for several quarters now. Online orders are driving revenue growth, and are on their way up. The roll-out of store continues in the UK. Domino already has more than 570 stores in England, Wales, Scotland and Ireland and is expected to open more than 30 stores in the UK in the next three months. Results abroad were a mixed bag. Tesco could use its massive infrastructure to push the Domino’s brand both domestically and internationally.

Domino’s stock isn’t cheap, based on trading multiples. It trades at a forward adjusted operating cash flow of 15x. That’s not ideal for Tesco, or for any other buyer in the retail sector, but then most assets along the food value chain trade higher than Tesco. With a price tag of 1.5 billion pounds, Domino’s would be a small bite for the UK’s largest retailer.

Prezzo Seeks Buyers

This relatively small chain of Italian restaurants is in talks with buyers. Prezzo has received preliminary proposals from Advent International and TPG Capital, two private equity firms, the company said on Thursday after rumours emerged in the marketplace. It operates 244 restaurants in the UK. As Prezzo said, any offer is unlikely to value the group above its current market value of about £310m. Why shouldn’t Tesco consider an approach in the next few weeks?

Prezzo stock trades at a forward adjusted operating cash flow of 9x, so it’s much cheaper than that of Domino’s. Its forward net income and operating margins are 9% and 12%, respectively. The Kaye family controls Prezzo, and also owns Tasty.

Tasty is a smaller target, with a market cap of about £60m, but it would cost much more than that to convince the owners to sell out. Finally, Restaurant Group, with a market cap of £1.2bn, is the biggest of the lot. Margins and growth prospects are enticing. Its valuation is not prohibitive.

Could Tesco buy them all? Seriously, I don’t know. But a bold move shouldn’t be ruled out, Mr Lewis…

In this tough market, are you still looking for opportunities? If so, you must consider a few shares that should be included in a diversified portfolio according to the rules presented in our brand new report.

Check out whether, according to research from The Motley Fool Team, the shares of Tesco and those of any other company mentioned in this article are worth a bet. Click here to find out more about the best strategy to implement right now. The report is completely free and without further obligation!

Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has recommended Domino's Pizza. The Motley Fool UK owns shares of Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.