Paying the right price for risk
Outlook improving: The UK pub sector’s market capitalisation has risen 95%
since January, helped in general by the market’s appetite for risk but specifically on
improved beer volumes trends, strong Easter trading, good disposal activity and
less negative operational leverage than feared. These have all translated into
margin solidity and consequently sector consensus forecasts have stabilised.
Established and emerging themes: We believe four key trends are likely to
dominate the sector debate in the next year: two old—licensee profit and asset
values; and two new—weaker eating-out trends and debt repurchases.
Leased pub imbalances: We estimate a 26% fall in rent from 2008 levels is
needed to restore the equilibrium between pubco and licensee profitability but
this is unlikely (we forecast a 15% fall from 2008E to 2010E), so questions will
remain, which will likely limit the rating recovery we expect.
Property values likely to decline 20%: £250m of asset disposals (at book value)
in the past six months have surprised positively but the weight of negative data is
difficult to ignore: commercial property 38% below peak, pub profitability down 14%
and a 23% decline in pub values between 1989 and 1993. We assume all
companies will see a 20% decline in asset values from peak by 2010E, which
implies a sector EV/estate value of 0.93x, suggesting the trough is priced in.
Eating out—the key threat for managed pubs: Recessionary real peak to trough
eating-out spending falls of 19%, increasing casual dining price competition and the
experience of the US (guest volumes down 10%) lead us to favour value-focused
JD Wetherspoon (Outperform, TP 448p) over mid-market Mitchells & Butlers (M&B)
(Underperform, TP 232p). M&B also faces a period of reduced investment capex,
which has historically driven 56% of LFL growth.
Debt market repurchases: The £12.3bn of listed pub debt trades 31% below
par and on blue-sky assumptions we estimate Punch (Outperform, TP 184p)
could sell £250m of pubs and retire nominal debt of £625m, thereby capturing
£365m of value (implying 106% upside potential).
Initiation of coverage: We advocate a balance of exposure to recovery valuations
and upgrade potential while avoiding outright premium ratings. Our preferred pick is
Enterprise Inns (Outperform, 224p), as we forecast the group will make progress
reducing debt ahead of the May 2011 refinancing. As such, we expect its 2010E
calendarised P/E multiple of 4.5 to increase. We rate JD Wetherspoon as
Outperform given what we see as its ideal market positioning and cost-related
upgrade potential (our 2010E EPS is 16% above consensus) and would avoid M&B
given high food (food and related drink sales 66%) and mid-market exposure (68%
of pubs) plus a lack of investment capex. Punch looks high risk (we expect all three
securitisations to be cash trapped in 2010E) but the blue-sky 106% debt buyback
upside potential justifies our Outperform. We initiate on Greene King (TP 464p) and
Marston’s (TP 172p) with Neutral ratings, noting better value elsewhere.
Table of contents
Investment summary 3
Valuation summary 5
Focus 1: Debt analysis 7
Focus 2: Property analysis 13
Focus 3: Leased model analysis 18
Focus 4: Structural & cyclical trend analysis 24
Focus 5: Sector forecasts 34
Enterprise Inns (ETI.L) 39
Investment case 40
Valuation 41
Leverage 44
Forecasts 47
Greene King (GNK.L) 50
Investment case 51
Valuation 52
Rights issue 55
Leverage 57
Forecasts 59
J D Wetherspoon (JDW.L) 62
Investment case 63
Valuation 64
Leverage 68
Forecasts 69
Marstons PLC (MARS.L) 72
Investment case 73
Valuation 74
Leverage 78
Forecasts 80
Mitchells & Butlers (MAB.L) 83
Investment case 84
Valuation 86
Leverage 89
Forecasts 91
Punch Taverns (PUB.L) 94
Investment case 95
Valuation 96
Leverage 98
Forecasts 98