Joseph Thomas of HSBC explains why he has a slight sense of unease over Mitchells & Butlers.
Dividend cut raises question: Trading at Mitchells & Butlers looks fine. Profit for FY 17a was as we expected, cost guidance isn’t meaningfully worse, and like-for-like sales up 2.3% in the first seven weeks of the year is a good outcome, even if it is against weak comps. True, we have cut our forecasts, but we view that as precautionary, with the group suggesting it could do better. So why axe the dividend? Management denies there’s a liquidity issue relating to its securitisations, and blames the potential impact of Brexit and the scenario of a future Labour government that might increase minimum wage rates and corporate taxes. This seems overly cautious in our view and it leaves us concerned that there might be some other potential risk out there that has not been fully articulated. We are cautious on the pub industry in general, but M&B, having agreed its pension deficit and with a successful self-help programme in place, looked better positioned than most. Ultimately, we think M&B simply returned to the dividend list too early, and is now setting that decision right.
The component parts look fine: Management says that its pub remodels and conversions are still generating year one like-for-like uplifts of c.10% and that these pubs are continuing to grow at c5% in year two, which is stronger than we previously assumed. We think that investing in the estate is absolutely the right approach and repositioning value pubs into new (often premium) market segments makes sense. On costs, we have increased our assumptions around headwinds, but we take encouragement from the granularity the group has given us on mitigation (mainly labour scheduling, thanks to a new system, but also procurement and other smaller changes).
Valuation − no quibbles: On an EV/EBIT basis, adjusted for pensions and other liabilities (eg swaps and provisions), M&B trades in line with Marston’s (MARS LN, 118p, Hold) and Greene King (GNK LN, 525p, Reduce) on 11.4x EV/EBIT for 2018e. Given the superior self-help story, the granularity around costs and mitigation and apparently healthy current trading, we would like to be more positive on the rating. However, concerns around the industry mean that the shares are unlikely to be rerated any time soon. As such, we see no reason to change our rating from Hold. We reduce our SOTP-derived target price slightly to 260p from 265p, still based on an adjusted EV/EBITR multiple of 11.5x, on account of the precautionary changes to our estimates.