Analysts at HSBC have assessed the likely impact of radical changes to lease accounting, which came into force at the start of the year, on the pub sector. They say the introduction of IFRS may lead to reappraisals of valuation multiples and could increase concerns about debt levels.
The report says: “The new International Financial Reporting Standard IFRS 16, which took effect on 1 January 2019, will have a big impact on all companies with significant leases that report under IFRS. Operating and finance leases, two distinct accounting models, are being replaced by a single on-balance sheet lease model. From now on, companies will recognise an asset and the liability (along with a depreciation and a finance charge) for all leases.
“The 30 year old IAS 17 was criticised because the financing provided by operating leases was off balance sheet, leading to companies reporting lower financial liabilities compared to companies that purchased similar assets with debt. “
Specifically on the pub sector, the analysts said: “For pub groups the main lease exposure is to property. They operate a mixture of freeholds alongside short term and longer term leases. Lease lengths can be extremely long: Marston’s, for example, cites lease durations of up to 30 years (vs. plant and machinery at 6 years). But operators are by no means uniform in their approach.
“Given the variance in freehold/leasehold mix, operating leases are one of the things that we have taken into consideration historically when calculating underlying gearing levels and enterprise values. As such, the changes being implemented by IFRS 16 shouldn’t come as a huge shock to those that have considered them in the past. However, as we show below, there will be a limited earnings impact which may mean that appropriate valuation multiples have to be reappraised.
Two other things to note:
Within the sector, the pub groups also operate as lessors, letting some proportion of their properties to tenants. IFRS 16 does not allow the operators an offsetting benefit. It is asymmetrical, penalising lessees but not benefitting lessors.
The lease profiles of Marston’s and Greene King are much steadier than those of MAB. We think that this may mean that MAB are only recognising leases until their break clauses. As such, calculating lease liabilities from the notes to the accounts could underestimate the actual impact. It would fit with commentary that we have received from MAB.”