Leading analyst Simon French, of Cenkos, gives his view on what the next 12 months is likely to hold for the pub industry. He asks whether Heineken and Patron Capital’s bid to takeover Punch will herald a new era of M&A activity and considers what this means for Amber Taverns, Enterprise Inns and Admiral Taverns. He also looks at what role Mitchells & Butlers, Greene King, Stonegate and The Restaurant Group will play in the evolution of the sector.
For a sector that has until recently been out of favour with institutional investors, the bidding war for Punch has made for a reassessment of the opportunities. An entity – Punch – that you couldn’t give away six months ago, is now being coveted by at least three suitors with Patron and Heineken currently favourites to acquire the company following the recommendation of their joint offer by the board.
An IPO of Stonegate has long been rumoured but we would not be surprised to see private equity reassess the potential for this asset with Lion Capital’s purchase of Loungers providing additional evidence that there is plenty of interest at the right price. We have read the speculation of Mitchells & Butlers ‘reuniting’ with Stonegate with interest but we think the dilution to freehold ownership is too much for the M&B board, and its major shareholders, to contemplate. However, we would not rule out other trade buyers being interested given the opportunity to remove duplicated costs – we estimate central overheads are in excess of £20m – and drive additional purchasing synergies.
We also expect to see movement with Amber Taverns, which has created a phenomenal wet-led business, predominantly in the north of England under the studious, but engaging, leadership of James Baer. We wouldn’t be surprised to see Stonegate itself being interested given the volume uplift and resultant synergies it would be able to generate while nudging up the freehold percentage of its estate.
Potential targets
The bidding war for Punch also shifts the spotlight onto Admiral Taverns, which has been quietly reorientating its estate and now has c1,100 pubs of commendable quality and highly skilled licensees, if our night in trade last year is anything like representative of the wider talent pool. We wouldn’t be surprised to see the under-bidder for Punch switch its attention to Admiral while there is also the intriguing possibility of Enterprise Inns returning to the acquisition trail given the freedom it has negotiated with its bondholders and progress with its new strategy.
Simon Townsend seems re-energised at Enterprise and we see scope for a material re-rating of the group’s equity given the favourable dynamics of index-linked income and fixed interest charges in the face of rising inflation. Also, there is intrinsic value being created with its managed expert partnerships, which will only become visible on sale, but we think there is scope to generate significant shareholder value in the long term through this process.
A Greene King merger with M&B is perhaps the most coveted transaction and one that was the subject of much speculation in 2012. Intriguingly, having gone through a process with the Competition & Markets Authority (CMA) relatively recently with the acquisition of Spirit Pub Company, the Greene King management team has the necessary insight, we believe, to plot a path to a relatively small number of pub disposals thus maximising the synergy potential we would estimate to be up to £100m.
We also expect The Restaurant Group, under the relatively new leadership of Andy McCue to be active in acquiring more pub assets, both to accelerate the growth of its Brunning & Price/Home Counties Pub Restaurants formats but also to look to develop a more mass-market, pub-based offering to complement its casual-dining brands. McCue understands the benefits of scale better than most having grown Paddy Power to a £3bn company prior to its merger with Betfair. A couple of years ago, we suggested that The Restaurant Group should merge with M&B and we still see merit in this idea not least due to the c£60m synergies available from such a transaction.
A new entrant into the sector during 2016 was Stellex Capital Management, which acquired the majority of the Chapman Group estate and rebranded as Dominion Hospitality. We understand Stellex has been looking at the sector for sometime and was close to acquiring a package of pubs from Greene King before withdrawing from the transaction, as reported by MCA. We expect Stellex to be active in any industry consolidation.
The weakness of the pound also raises the prospect of more overseas investment in the sector with US dollar funds enjoying a c17% increase in their purchasing power of UK assets. This would also suggest more investment from overseas funds, including China, which has taken tentative steps in the sector with the purchase of David Cameron’s local following the visit of Chinese President Xi Jinping. The attractions of owning British real estate remains high for emerging market funds and we therefore expect significant unsolicited interest.
Expect a tough first quarter
Despite a widely buoyant Christmas period for pubs, we expect trading will be tough with a particularly difficult Q1 expected, exacerbated by the late timing of Easter. We anticipate consumers will hunker down post Christmas with large credit card bills to pay and falling confidence reflecting less job security post Brexit. We think London pubs will struggle as customers look to spend more time at their desks to remind their bosses of their productivity! We don’t expect a material increase in overseas visitors given ongoing security concerns with the tragic events in Berlin before Christmas – another indicator to US and Japanese visitors that Europe remains a volatile region.
Costs will rise significantly due to the weaker pound, national living wage and national minimum wage increases and the much talked about business rates increases. We estimate that units will require 3% to 4% LFL sales growth to keep cash profits flat. We also see no abatement in this with rents also likely to rise given the ongoing supply growth in the food-led sector. While this will all result in a difficult year for operators, for investors the opportunities look more positive than for some time.
