Graeme Smith AlixPartners (3)

The pub customer has proven resilient in the face of the cost of living crisis, backing the view that pubs form part of consumers’ everyday lives, according to AlixPartners.

Speaking at MCA’s Pub Conference last week, Graeme Smith, MD at the financial advisory and consulting firm, told delegates that customer behaviour has diverged between restaurants and pubs in recent times.

Customers have cut back on visits to restaurants but protected their spend when they do go out, particularly for occasions. Pubs, meanwhile, have seen customers maintain frequency, albeit this is sustained by economising on spend per visit, according to Smith.

With wage growth now outstripping inflation, he is optimistic the sector should see a bounce back in consumer confidence.

“I’m pleased to stay as we stand today, some of the economic data is starting to help now,” he said. “Inflation is coming right back down to that target level of 2%…wage inflation is now running at a higher level and people feel as though they have more money in their pockets.

“We do start to see this coming through in consumer confidence.

“The last key thing we’re looking to see coming down is interest rates…all of those things start to build an environment where there’s hopefully a positive push in terms of trading.”

The increase in National Living Wage – while adding a cost burden on to operators – has allowed some consumers to have more discretionary spending power, he added.

Smith emphasised that pubs’ like-for-like revenue has remained robust, with all-day trading and accommodation in particular boosting performance.

The outcome of this market backdrop has resulted in a mixed picture for listed pub companies’ share prices, however. Mitchells & Butlers currently stands highest in terms of market capitalisation, followed by JD Wetherspoon, and Fullers.

Despite positive trading results, this has not entirely translated to valuations, with Young’s and Marston’s seeing marginal declines in share price between January 2023 and June 2024.

A broader recovery in prices seems dependent on sentiment improving, Smith added.

He went on to outline the common themes that have driven M&A activity in the pub sector over the past 15 years: scale and exit to trade; cheap debt-based expansion; and investment-led upgrades.

The first saw a clear size valuation premium and a race to scale for largest groups, alongside retail to wholesale trade. The era of cheap debt saw the income yield on pubs offering cash-on-cash return, with access to debt a competitive advantage. Investment-led upgrades led to a highly fragmented pub market with well-located but poorly invested units ripe for investment, along with benefiting from the food-led trend.

These drivers have now changed due to shifts in the market. The race for space has ended, while debt is much more expensive and the overall pub market has shrunk.

“We’ve seen an end to that race for scale,” Smith explained. “There’s been mergers, demergers, splits…quite a lot of change from that perspective. It’s been very much a tale of rationalisation.”

The operational rationale is now facing much more scrutiny, with deals expected to contribute to operations, proposition, or geography, leading to a focus on synergy benefits.

“It’s much more about what is the strategic rationale for a bigger player to buy a smaller platform,” he continued. “What does it bring to the acquirer?”

Examples of such deals include the Liberation Group and Cirrus Inns merger, Youngs’ acquisition of City Pubs Group, and Greene King’s acquisition of Hickory’s.

The pressure on ability to drive returns on investment is also much higher due to more expensive debt. This has resulted in more active portfolio management, and investment capital is therefore challenged to priority areas.

Smith pointed to examples such as Fullers’ sale of 37 pubs to Admiral Taverns, Marstons’ sale of 19 sites to Red Oak Taverns, and Punch Pubs’ acquisition of the former Wear Inns portfolio.

Premiumisation continues to drive returns in food-led sites, with rooms and entertainment also distinguishing themselves as major focus areas for pubs.

“The investment-led proposition is still really important.”

Smith further highlighted the common areas of focus for investors: operator-led models driving growth; active tenant and operator management; existing accommodation capability and ability for its expansion; opportunity for investment-led growth through the existing estate and acquisitions; and the quality of the management team for larger deals.

“We’ve seen the evolution of what is the right model for a pub. Investors are also looking for much more active management…accommodation also comes up time and time again, with the UK underserved when it comes to room supply. People are also looking for high quality management teams that have the ability to do more and scale up.”

The catalysts for deal activity in the coming year include continued estate churn by large groups, along with loan maturities and financing challenges.

Acquisition of premium portfolios and management capability will continue to be drivers. The allocation of real estate capital to pubs, combined with a reduction in interest rates and a return to margin expansion, round off the list.

“Debt capacity won’t be what it was, so either people are going to have to put in additional capital to pay debt, or look at the sale of the business as a whole,” Smith said.