J.P. Morgan Cazenove on Marston’s and M&B

After strong outperformance in 2019, we are moving MARS and MAB to Neutral, from Overweight, as the current share prices have now “caught up” to reflect the fundamentals, in our estimation. MAB’s operational performance inflected during 2019, and MARS largely resolved fears around its leverage and dividend sustainability. In addition, sector M&A activity has directed focus on the value of both companies’ property estates. We are Neutral on the UK pub sector more broadly, and, for now, see an absence of significant catalysts in either direction. We leave our target prices unchanged.

• We believe MARS lacks an obvious catalyst for another substantial price step-up in the near-term. The valuation is now close to fair, with the dividend looking secure at a 6% yield. Over 2019, management has taken decisive action through their detailed and suitably aggressive deleveraging plan, which has assuaged market concerns over leverage. This has contributed to the strong share price performance in 2019 (along with the sector M&A that has highlighted the latent value of MARS‘s 93% freehold estate and beer business). However, MARS currently lacks substantial growth levers, with pricing/margin under pressure and new site development discontinued in the near-term. We acknowledge that heavy disposals activity is raising the average quality of estate, and this presumably will be beneficial to both margin and LFL prospects in FY20E and beyond; we forecast 3% EBIT growth in FY20E. However, in our view the current valuation is close to reflecting this.

• MAB’s share price has rallied by ~80% from the May 2019 low, buoyed by M&A activity as well as the sustained robust LFLs and stable margins. We now feel that the current valuation is close to fairly accounting for MAB’s operational improvement. Underlying operations have improved materially from the impact of Ignite 2 in 2019. LFLs in FY19 averaged 3.5% (2.4% on a two year average basis), vs 1.3% in FY18 (1.5%). MAB’s recent LFLs are particularly impressive in the context of many of their brands being in the mid-value segment, such as Harvester, Toby Carvery and Ember Inns. This segment has suffered a particular squeeze from the proliferation of mid-market concepts. Moreover, slight margin expansion in FY19 (+10bps) was highly surprising given the MAB is fully managed operator and hence bears the full brunt of high cost inflation. Operating performance seems to be on a sustainable footing, but there is little moderation in cost pressures in 2020, nor a particularly bright outlook for mid/value food-led establishments. Although the Ignite and Ignite 2 programmes have delivered impressive results, the question remains on whether incremental gains will be lower? At this juncture, we forecast flat operating profit growth in FY20E, implying a slight margin decline, but feel there is some upside risk for earnings. There are two remaining upside catalysts, apart from further operational gains; 1) a favorable court decision regarding the pension liability, 2) dividend re-instatement. While we have no insight on the court case it is certainly an option of some description for MAB. Unfortunately, MAB’s intention to only pay dividends from cash flow post-securitisation debt service means that the dividend is unlikely to be resumed until c. FY23.

• We are squarely Neutral on the UK Pub sector. Our “Neutral with a positive tilt” stance for the sector in 2019 has gradually given way to a more balanced Neutral view for 2020. Firstly, we see limited scope for operational performance materially above expectations among our coverage. Our base case is for another year of positive LSD LFLs; we can see no compelling reason for LFLs to inflect. We also note that pubs have already had more than two years of implementing cost mitigation and this surely is becoming incrementally more difficult. Secondly, M&A activity means that share prices now appropriately reflect NAVs, as attention has been drawn to the underlying value of the pub estates. Thirdly, cultural change continues to occur. As the volume of alcohol consumed declines, premiumisation and diversification needs to offset. The value of pubs as community focal points will remain, but emphasis on quality experience entails higher structural capex requirements and focus on prime sites. Finally, oversupply in value/mid-end food may be correcting, but the process is slow, and may not be supportive until 2021 at least. All in all, we view the sector risk/reward as more balanced now.