Spirit Pub Company has come a long way since its demerger from Punch Taverns over two years ago. It is arguably a better run company with good concepts, while the completion of a refinancing this morning adds further momentum behind the business. However, despite consolidation in the pub sector coming back into play, reports that the Mike Tye-led group is considering a bid for rival Orchid seems at the moment a case of the business running before it can walk.
As analyst Jamie Rollo pointed out last week, Spirit appears to be a different company from the underperforming business it was under Punch. Since F2010, cumulative like-for-like sales are 11.6% higher, EBITDA per pub is up 35%, EBITDAR margins are up 390bps, 86% of the estate is now invested/branded, and guest and employee advocacy have improved to c75%.
At the same time, its “Pub in a box” IT system has led to 60bps GP margin improvement, less local discounting, less theft, less admin for the general manager, improved staff rostering, and allowed better cost control. It also has a number of good concepts, including Flaming Grill and Fayre & Square.
Spirit is looking to secure freeholds that are suitable for both, with expansion set to begin in the second quarter. “We believe there are a lot of pubs in the UK that are not being optimised at the moment,” Tye told M&C Report recently, adding that he believed Spirit’s “magic dust” could get “good results”. Newbuilds are not on the agenda for the time being. Tye added: “Don’t expect huge numbers [of acquisitions] in FY13. In future years I think you will see that accelerate.” Spirit re-stated its ambition to grow to 1,500 sites and Tye said he believed each brand could have 200 outlets without risking canibalisation. 20% returns on investment are sought.
With the group’s leased pub estate now showing signs of stabilising, this morning’s refinancing of the group’s A1 and A3 bonds should pave the way for this return to expansion, which should include the further roll out of the group’s new Flaming Grill-lite format, with early trials achieving double the company’s return hurdle rate.
However, while these concepts have gained traction, it is one of the group’s most established brands that is seemingly still causing it some concern. For me Chef & Brewer was always the group’s more premium offer, however the launch earlier this year of its trial Premium Pub & Dining format raised questions as to where the brand now sat, with Tye admitting the brand started out as “something quite premium” but moved to being more mid-market.
Two sites have been converted to the Premium Pub & Dining format so far, the George in Belsize Park at the Cricketers in Kew Green, and Tye said they are “performing very well”. He said that there are a “number of pubs” currently branded Chef & Brewer and Taylor Walker that could suit the format.
Tye also said that a trial was underway of a version of Chef & Brewer that’s “slightly premium to what we are doing now”, with a “slightly better menu” and “better food quality”. The typical cost of changing the brand to its more premium format is c£30,000 to £40,000 each. It will be interesting to see what points of differentiation appear as the two formats evolve.
There is also concern that the group’s impressive performance over that last two years is unduly weighted towards its investment programme, with recent trading mixed and the outperformance gap with the rest of the market appearing to narrow.
Rollo says: “Spirit has invested far more in its pubs in recent years than peers and we are concerned that its outperformance appears to be narrowing as capex slows. Nearly all of Spirit’s pubs have been invested in, and average weekly take has increased by an impressive 13% since F2010, although still remains c.30% below leading peer Mitchell & Butlers, due to structural reasons we think (M&B has larger sites and more branded pub restaurants).”
So how does it continue to move the dial? As mentioned above, it has already stated its ambition to grow to an estate of c1,500 pubs, but so far has only talked about securing a handful of sites in FY2014 and on acquiring individual non-branded freehold pubs. However, buying a handful of pubs each year is costly, and will not dramatically change the company’s structure. Rollo says: “We think Spirit would need to acquire another managed operator for expansion to be material, and this looks unlikely right now given its tight cash constraints.”
Hence the glance in Orchid’s direction, but also the scepticism of whether Spirit, and it more importantly its shareholders, have the stomach and funds to enter what is thought to be gearing up to be a competitive bidding process, one in which a private equity play looms large. Despite first round bids due this week, it is thought that there is a long way to run in the process for Orchid, which is valued between £250m-£300m, with the Rufus Hall-led group generating widespread interest from private equity and trade buyers. There are also concerns over whether Orchid’s estate could prove an easy bolt-on for a trade buyer, although the TDR-backed Stonegate has proved adept at overcoming such hurdles.
Spirit’s refinancing this morning is a first step in raising funds for further expansion, around £53m according to Douglas Jack at Numis, but the company would need to ask shareholders to put their hands further in their pockets were it come to cementing its initial interest in Orchid. It is now well placed to benefit from a pick-up in the UK economy and to continue to take further market share. Perhaps it is best for now for those hands to give polite applause for being in that position and the work Tye and his team have carried out to get them there over the last two years or so.
