BDO: Whose round is it next?

M&A continues at pace in the pub sector, with the latest transaction being CK Asset Holdings’ proposed acquisition of Greene King, demonstrating that visits to British pubs remain an enduring activity in the minds of consumers.

Following a significant clear-out, pub numbers have been steadily decreasing from c.60,000 in the early noughties to c.46,000 today. The supply side dynamic in the sector is markedly different to the oversupply seen in casual dining, enabling strong operators to generate like-for-like revenue growth. A number of wet-led managed operators such as Young’s, Fullers and City Pub Co are doing just that and continued to deliver strong performance in what are still challenging conditions.

In addition, many of the listed pubcos have worked on rationalising their portfolios over this period and are now left with high quality estates, increasingly prepared to respond to consumer trends towards premiumisation, localised offerings and experiential activities.

And unlike the casual dining sector or bricks and mortar retail, the listed pub sector’s largely freehold (c.80%) asset backing provides a level of resilience to the sector.

One could argue that the driver behind both Stonegate’s acquisition of Ei and CKA’s GK acquisition is in the property; investors are seeing the underlying value in pubcos, underpinned by their substantial freehold make-up which has not always been fully reflected in their share prices. As a result, UK pubcos are presenting an opportunity for investors to acquire asset-backed UK businesses in what is a relatively stable sector, despite the challenging wider UK macroeconomic climate.

You also can’t ignore the impact that the decline in sterling has had with overseas investors now able to invest in UK assets at materially lower prices (c.20%) than in recent years. No doubt this was not overlooked by Asahi or CKA when appraising their investments and we expect this trend to continue.

Common themes are still very much present in the market:

• Local focus: Operators are increasingly taking a hyper-local approach to site design, tailoring sites to meet the needs of local communities and embracing the pub’s history, rather than applying a ‘cookie-cutter’ approach.
• Authenticity and provenance: There is an increasing demand from consumers for authenticity and provenance. The ongoing consumer shift from branded operators towards a preference for ‘independent pubs’ is continuing.
• Experiential propositions: The preference for experiences over material goods is only strengthening as the search for ‘instagrammable moments’ continues. Groups like Inception Group (Mr Fogg’s), Incipio Group (Pergola), Laine Pub Company and New World Trading Company (NWTC) are great examples of innovative brands creating memorable guest experiences.
• Premiumisation: Increasingly pub groups are differentiating themselves with premium drinks offerings. City Pub Company has been a fantastic example of this strategy, combining authentic, locally tailored pubs with a great premium proposition.
• Accommodation: The opportunity available for pub groups to ‘sweat their assets’ fully and take advantage of the boom in accommodation sales (and the ever-growing popularity of the staycation) is not going unnoticed. Operators are continuing to explore converting unused ‘upper parts’ and we expect this to continue.

Looking forward

Looking forward, the attractive multiples achieved for Fuller’s, Ei & Greene King will no doubt make competitor CEOs, boards and shareholders start questioning what their value could be outside of public markets.

The transactions certainly impacted the share prices of other listed pub groups in the days proceeding the Greene King announcement with Marston’s +16%, Mitchells & Butlers +10%, JD Wetherspoon +7%, City Pub Co +6%, and Shepherd Neame +5%.

Marston’s diversified portfolio and substantial freehold base will no doubt be attractive for some, alongside Mitchells & Butlers which also looks comparatively cheap relative to its peers at 7.6x EV/CY EBITDA. We wouldn’t be surprised if offers came in for either party over the next 12 months.

The sale of Fuller’s brewery highlighted the value within brewing divisions and it will certainly be interesting to see what CKA’s views are on the Greene King brewing division. Similarly, Marston’s may consider exploring the value of its own brewing arm which contains a number of heritage brands that could be appealing to investors. The Fuller’s transaction has shown that the benefits of a fully vertically integrated model may not be what they once were.

A clear difference in the pub sector compared to casual dining remains the existence of a much broader and varied trade buyer pool. As a result, we expect well-capitalised groups such as Punch, Young’s and Stonegate (once it has digested Ei Group) to continue actively looking to acquire in the space.

Furthermore, with Fuller’s having the proceeds of the brewery sale sitting on its balance sheet, watch out for the Simon Emeny-led group looking at selected M&A activity over the next 12 months to drive growth.

Private equity interest in the sector remains strong. Equity houses, who are sitting on substantial dry powder, are still actively looking in the sector for quality operators with differentiated propositions who are able to demonstrate the ability to scale and deliver strong returns.

There continue to be a number of exciting fast-growing managed pub and bar groups that are likely to be on investors’ radars, presenting the possibility of further consolidation in the pub arena.

Groups such as Drake & Morgan, NWTC, The Alchemist, Brewhouse & Kitchen, White Brasserie, Red Mist Leisure, Chestnut Group, Anglian Country Inns, and Inception Group are all likely to be receiving knocks on the door.

Watch this space: it feels like the sector will continue to be active for the foreseeable future.