Leading analyst Jamie Rollo, of Morgan Stanley, has posed some key questions for the management of Enterprise Inns, which yesterday gave an update on the overhaul of its business.
Among the questions posed by Rollo are whether the company would consider buying a managed pub company to grow its expertise and scale.
Rollo said his stock rating for the company remained at ‘underweight’ after FY results that showed a ninth consecutive quarter of like-for-like net income growth and encouraging tenanted pub KPIs but also revealed another asset write-down, guided to ongoing overhead inflation, and initial pub managed KPIs which look weak.
He said: “We think Enterprise’s 5 year strategic plan is sensible, but optimistic, and think the build-up of the managed business will lead to higher than expected central overhead, that the free of tie conversions may lead to a bigger than expected initial net income loss, and that the retained tied estate may need to be offered better terms not to take up the MRO. Hence, we see something of a gentle U-shape EBITDA trajectory, amplified at the EPS level due to leverage.”
The questions he posed for the company were as follows:
1. What does the company think LfL net income will run at in FY16 (target is for it to be positive)? Was there any boost from the Rugby World Cup in Q1? What would LfLs have been if the level of business failures reduced from FY15’s 8% to the target 6-7%?
2. What would FY15 LfL net income growth have been excluding the benefit of capex? The boost from beating the 15% ROCE hurdle on 2014’s capex (£66m, of which 41% on expansion) should have added at least £4m or 1% to net income on our calculations, so does this mean uninvested LfL was net income negative?
3. Could you discuss the reasons behind] Enterprise reporting another property write-down (2.7%) when LfL net income has been in growth for 2 consecutive years?
4. How achievable is the 5-year plan? Is management remuneration linked to the targets? What early indications of progress has the company seen ?
5. What does the company expect the impact of the MRO to be? Could management break this down into: lost net income on pubs that will go free-of-tie post the new rules, lower lost income from tied pubs that need to be persuaded to opt out of MRO, beer income on the remaining tied estate from lower purchasing scale, lost capex opportunities, and higher landlord maintenance capex as fewer long-term contracts are offered?
6. What is the company’s view on the draft Pubs Code legislation? Campaigners worry that section 8.12, which states that a tenant will only gain the right to request MRO following the receipt of a rent proposal if the rent proposed by the pub company is higher than the existing rent, is a ‘get out clause’ for pubcos. Does Enterprise expect the clause to remain in the Code? Does it expect Parallel Rent Assessments to remain in the Code?
7. What exit multiple should we assume on the targeted 1,000 / £300m pub disposals? Should we assume another NAV write-down on the disposal pubs? How close is Unique to its disposal limits?
8. Could management provide insight into why weekly sales in the initial Managed pub conversions are below target (e.g. Bermondsey model £11k vs £12-18k target, Craft Union model £7k vs £7-12k target)? This is despite higher than expected capex. Are most of the target pubs subscale in terms of unit sales, particularly with growing wage cost pressures? What sort of overheads should we assume for the new Managed pub estate? Will additional cost increases here be offset by savings in the tied estate as that shrinks?
9. Does the company think the rise in net income on the 28 pubs that converted to free-of-tie is representative? What should we assume on the average conversion post MRO regulations? How much net income could be lost as the higher rent is insufficient to offset the wet rent? What multiple would the company put on income from a pub that is not tied as opposed to one that is tied? Is the 8.4% yield in its valuation reasonable?
1 0. Is it reasonable for us to expect a ‘U-shaped’ profit profile, with upfront overheads to build the new managed business (plus the impact of higher depreciation and profit sharing with third parties), a drop in income for the free-of-tie pubs (as the rent increase will not fully cover lost beer margin), the remaining tied pubs being offered incentives to stay tied, and overheads unlikely to drop as much as the c. 50% drop in tied pub numbers?
11. Does the company have the option to refinance Unique in order to extract cash from it? Currently Unique needs a £15-20m annual cash injection from Enterprise Inns to fund its debt service, meaning it is a drag on PLC FCF. In your view, would the best outcome with Unique bondholders be to ask for more flexibility for its managed and commercial property models? Could management approximate what a refinancing or reprofiling might cost Enterprise, and clarify whether it may need to raise new equity (or another convertible bond) given its high leverage levels?
12. How substantial is NAV support, particularly if we strip out intangibles, assume another write-down, and adjust for a possible refinancing of Unique?
13. Would the company consider acquiring a managed pub company to grow its scale and expertise in this area?
