Punch Taverns executive chairman Stephen Billingham talks to M&C Report about the impact of the market rent only option on the tenanted and leased pub sector; moves to establish a managed and franchise operation; why Duncan Garrood is the right man to take the company forward and why he would not rule out a move into coffee shops.
Financial performance
Billingham said Punch’s performance to 7 March 2015 showed the company was “on the right track”.
He said: “The investment case at Punch is all about debt reduction and we are on track to deliver £200m worth of debt reduction in the next three years.”
He said the focus remained on growing income within the core estate, which generated 90% of EBITDA during the period, and maximising short-term returns in the non-core estate.
Average net income per pub is up 5% across the entire estate in the half year, driven by disposals of non-core sites.
The non-core estate is currently split into 344 pubs being protected, 205 being sold at a later date and 210 being sold now.
Gold bricks
It is not just in the non-core estate that disposal are being made –with a total of 186 sites from the core estate being disposed of since September 2010 (compared to 1,554 non-core pubs).
Billingham said the company would continue gold brick disposals on an opportunistic basis.
He said: “They are predominently London and where people are coming along and offering exceptionally good prices which we can’t refuse. You are looking at tens rather than hundreds, but we will continue to consider offers.”
MRO
Billingham described the decision to include the market rent only option in the pubs code as “the one cloud that is hanging over us”.
He said: “The MRO goes to the heart of the leased and tenanted business model. We make our money from rents and selling beer at volume. If we can’t get the beer volumes through our pubs then what incentive is there for us to invest? It’s a fundamental principle that I don’t think the MPs understood at all, despite us sharing a lot of information with civil servants and ministers.
“I’m less concerned about the pubs code in general because it is just an extension of what we have been doing already. There are a lot of it is sensible business practices in there and I want to be an early adopter of anything we possibly can. What we want is to make sure there’s nothing that ends up being counter-productive.
“The other thing that concerns me is the role of the pubs code adjudicator and the fact that the process could end up being very expensive.”
He said the relationship between Punch and its tenants would inevitably change if they took up the MRO option.
He said: “The relationship will be quite different to the one we have at the moment. There won’t be that soft relationship – we will be a commercial landlord and will act as a commercial landlord.”
Legal action
One of the options open to Punch is to mount a legal challenge against the Government for what the pubco considers a contravention of human rights legislation.
Billingham said the option was still being discussed.
He said: “Taking legal action against the Government isn’t something you do lightly. If we issue a legal challenge it has to be within six months of the bill getting royal assent but we need to carefully consider the pros and cons of doing it.”
Asked if Punch had engaged with other pubcos to discuss joint action, Billingham said: “When we have worked out what we want to do its sensible to talk to others but at the moment we are looking at what is right for us.”
Managed and franchised divisions
One of the ways in which Punch is seeking to mitigate the likely effects of the MRO element of the pubs code is by establishing managed and franchised businesses.
Billingham said: “We have no managed house capability at the present time at all. We are looking at franchised capability. We will in due course establish some managed house capability, we need to.
“There is a huge amount of work to do in setting that up. All the expertise on managed went to Spirit in the demerger so we need to reinvent that expertise.”
He said the company would trial a variety of operating models and said “a big handful of sites” had been earmarked for management.
Mighty Local and Champs
Over the past year Punch has also been developing two quasi-managed models – Mighty Local and Champs.
Billingham said: “They are trading formats rather than contractual formats so very different from what we need to look at in managed.
“Champs is a sports bar format that has potential to be rolled out further. The questions are how much do we keep control of the brand and how far can we roll it out.
“Mighty Local is not a brand. It’s a way of addressing a wet-led market and re-generating wet-led pubs.
“The scope for Champs is pretty small because there are only certain sites that it will work in.
“With Mighty Local, there are elements of it that can have value across a large number of sites. There might be aspects we can transfer into other wet-led pubs.”
Foundation tenancies
Billingham said the majority of tenancies were now under the company’s foundation tenancy model.
He said: “It’s more of a support model. About giving more support to partners coming into the pub business. It comes with a mass of up front support. That has been very helpful. One of the issues I was struck by when I joined the pub business was the lack of visibility we had on how partners were performing and therefore how we could help them.
“It’s about creating those disciplines from very early on.”
Capital investment
Another action being taken by Punch in light of the regulatory changes is to defer some capital investment.
Billingham said: “We haven’t deferred many. They tend to be where the spend is quite large and the payback is more than five years. The reason is quite simply why would we want to go out and spend lots of money and run the risk of an MRO at five years and we don’t get out return.
“The dilemma then is what do you do with those sites, how do you get them to work? That is the challenge that MRO brings us. They are sites where historically we would have certainly made investments but because of MRO we are thinking again and it could well be that we end up selling those sites and they stop being pubs.”
Duncan Garood
New chief executive Duncan Garrood joins Punch in June from international franchise operator MH Alshaya.
Billingham insisted Garrood’s experience in franchising was not the primary motivation in his appointment.
He said: “The MRO proposals and the implications of that did make us shift our focus from people within the pub sector to consider a broader range of candidates.
“I wouldn’t get hung up on franchising but it was important to us that we had someone who had experiences of other ways of doing things. I wanted something with a strong retail background and understands the structures around it.
Neil Griffiths
Chief operating officer Neil Griffiths had been seen as a strong contender for the role of chief executive.
Asked whether Griffiths was likely to continue in the COO role, Billingahm said: “Neil continues to be chief operating officer of the company and will continue to be when Duncan arrives. There’s no change there. “
Coffee shops
Asked if Punch Taverns could ever diversify into the coffee shop market, Billingham said: “We run licensed premises but that doesn’t mean you don’t look at how you might widen the offer. We are thinking about how you spill over the premises we have into that market to allow all day trading.
“Going forward that’s certainly an area we will look at. I don’t think for one minute that we’re going to have a massive coffee chain in six months but in five years it could well be that you find pubs are offering more. There will be areas where in the day it’s more of a coffee shop and at night a pub. It’s what Wetherspoons are already doing so why can’t we.”
Analysts’ response
Paul Hickman, analyst at Edison Investment Research, said:
“In its first results since the October capital restructuring, Punch is showing convincing signs that it’s horrible history of over-indebtedness stretching back to 2008, is on its way to being turned round. Reporting first-half EBITDA of £105m for the half year to August against £108m the year before, the company is on course for its full year forecast of £193-200m. LFL net income in the core estate continues to move in the right direction at +0.5%.
“The restructuring arrangements finalised last October mean that most of this cash is now appropriated to debt service and reduction for some years to come. But this is the best use Punch could make of its cash, given its still heavily indebted balance sheet. In fact, net debt reduction of £54m since October looks like a very good start against management’s target of £200m over the next two years. The raising of the disposal full-year target from £60m to £80m gives further confidence in that regard.
”There is much to do, and Punch’s management under executive chairman Stephen Billingham appears to have the appetite to do it, even before the arrival of the new CEO in June. By 2017, the balance sheet could look much more sensible with gearing at 150-250% rather than the current level of over 400%. For the moment, we think investor interest is still likely to be a little specialist. However, the balance sheet has been stripped of repayment risk, and the selected core trading estate is one that can be relied on to retain its cash generative properties. At this early stage the EV:EBITDA discount to pubco peers of c.20% appears appropriate, with the proviso that the potential to close it over the next two years could create some useful returns for investors with a little patience.”
Mark Brumby, of Langton Capital, said: ”Punch has managed to reassure that trading is in line with expectations and disposals are ahead.
“H2 comps will be tougher, uncertainty remains as to the impact of the MRO legislation and, with the best will in the world, there’s very little that can be done about that. This may put some investors off but it is what it is.
“However, Punch looks set to evolve its model. It ‘needs to’ put in place a managed offer and it is also looking at franchising.
“Elsewhere, disposals continue, debt is falling and the capital structure is ‘robust & sustainable’.
“Earnings numbers suggest that the group is cheap but, with the business model in flux, they are likely to change over time.
“We would suggest that there is material upside potential within Punch. Profits can move quickly when they are the difference between two large numbers (EBITDA + interest paid) and we believe that trading is stabilising.
“Punch’s shares may remain out of favour until we have some certainty as to the MRO. However, its shares will comprise a large part of the small cap index and, as such, the upside represents a risk to non-holders who are benchmarked against it.
“We would suggest that the shares are worth a look.”
