Jamie Rollo at Morgan Stanley looks ahead to the Q4 trading updates from Spirit Pub Company due on 4 September and expects solid trading across the group’s managed estate but continued weakness in leased, and sees downside risk to forecasts.
He said: “We expect weaker comps and key events to prove broadly supportive in both the managed and leased estates. For H2, we expect revenue of £368m (+3%), EBITDA of £76m (+7%), PBT of £31m (+31%), EPS of 3.5p (+36%), and DPS of 1.3p. We are broadly in-line with consensus for the full year, but with Spirit needing over 30% PBT growth in H2 (versus -5% in H1) to make our forecasts, we see some risk. We remain Underweight the shares as we are worried about Spirit’s weak FCF generation, debt structure, and think LfL sales will slow once capex levels normalise.
“Spirit reported invested LfL sales growth of 3.7% during its Q3 IMS, representing a continued slowdown from Q1’s +6.2% and Q2’s +4.6%, though this reflected tougher comps and poor weather. The company did not supply an uninvested figure, though we think it was flat or slightly
negative given it was up “marginally” in Q2 when the headline invested figure was +4.6%. We expect fairly robust trading figures in Q4 supported by key events and weaker comps. Both the Diamond Jubilee
(Mitchells & Butlers +4% LfL growth for its duration) and the Olympics (c. ¼ of Spirit’s Managed pubs are in London) should boost trading. With M&B reporting +0.4% LfL growth at its most recent update versus +6.1% at JDW and +7% at Greene King we think the range of results is wide, however with comps weakening (+3.8% Q4 ‘11 versus +7.3% Q3 ‘11) we expect LfL trading around the +3.7% seen at the Q3 update.
“Spirit’s leased estate has not been trading well for some time. LfL net income in the estate declined by 8% at the Q3 IMS, representing a further deterioration from Q2’s -6.3% and Q1’s -3.3%. Poor weather and rent rebasing have acted as headwinds, though trading has been disappointing despite this and much worse than peers. For the Q4 trading update comps ease to -3.3% (-0.7% Q3 11), the Euro 2012 football should act as a tailwind to the wet-led estate, and Spirit is in fully control of the estate now. A repeat of Q3’s 8% decline would suggest a full year LfL net income decline of over 6%, which we think could cause the shares to de-rate, and would act as a stumbling block for disposals within the Leased estate (the target for which was increased to 100 pubs from 80 pubs at the time of the H1 results). We do note the encouraging trading at Enterprise, which saw 1.7% LfL net income growth in its substantive estate over the 18 weeks since the H1 results, versus +1.5% at H1.
“As of its Q3 results Spirit had refurbished 177 of its managed pubs, an extra 21 since the H1 results. The company said that it expects minimal investment in the final quarter of the year, suggesting that the original year end target of 200 refurbishments will be missed. Hitting this target would mean that around 85% of the state has been fully renovated. 10 pubs were converted from Leased to Managed and the company said that it was monitoring the performance of these conversions before considering the pace of the program for next year. Given these comments we do not expect much in the way of estate changes in the final quarter, reducing the capex bill and lost trading weeks from closed pubs but potentially representing a hit to headline LfL trading figures as capex levels fall.
“For 2012, we forecast L4L sales in Managed of +4%, and -2% L4L net income in Leased. We expect revenue of £762m (+4%), EBIT of £109m (+4%), PBT of £50m (+14%), and EPS of 5.7p (+17%), leaving us in line with consensus PBT of £50m and 5.8p respectively. H1 PBT fell 5% reflecting some provision reversals, and this implies 30%+ growth in H2 PBT to hit our and consensus forecasts. The company says it remains on track to deliver on its full year expectations.
“Our Underweight on Spirit’s shares reflects several key factors. First, FCF is low due to high capex levels, high debt levels, and some loss-making leased pubs, and the PLC cash is being drained without a chunky upstreamed dividend from the securitised debt vehicle in which all the profitable pubs reside. Second, while the Managed pubs offer catch-up potential to M&B trading levels, average unit sales and margins have always been lower than MAB for structural reasons, and the impressive sales growth rates will fall now the investment program winds down. Third, the Leased pubs (c 40% of EBIT) are trading very poorly, and while we think Spirit’s plans to sell many of these makes sense, it will be heavily dilutive, we forecast. Finally, EPS drops by around 15% iff we do not give Spirit the benefit of its lease provision. The shares still look fully valued on 9.7x 2012 P/E and 8.8x EBITDA (or 11.4x and 9.7x respectively adjusting for the OLP provision) and we remain Underweight.”
