Leading analyst Douglas Jack at Numis Securities says that net debt/EBITDA ratios are falling due to EBITDA growth in managed pubs and debt reduction in tenanted/leased pubs and that this seems set to continue due to stable capex plans.
He says: “The restaurateurs are stepping up their expansion, but with new sites continuing to be financed out of internal cash flow. Due to large variations in property tenure, our preferred balance sheet metric is cash fixed charge cover, on which basis Fuller Smith & Turner and Domino’s Pizza have the strongest balance sheets in the sector by a comfortable distance.”
Jack says that investors continue to indicate concern when net debt/EBITDA exceeds 5x. He says: “However, in defence of the residential pub operators, their orientation to freehold/long leasehold property is high. In addition, these companies are generating strong cash flow, which is being used to either pay down debt or increase EBITDA through expansion, resulting in net debt/EBITDA ratios falling gradually in almost all cases.”
The vast majority of sector debt is securitised to beyond 2025. Jack points out that Greene King, Marston’s, Mitchells & Butlers and Spirit Pub Company are, and should continue to be, able upstream cash from the bonds to facilitate the payment of dividends to shareholders.
He says: “Enterprise Inns looks set to avoid joining Punch Taverns in being cash-trapped when its
Unique bond starts to amortise as a result of repaying some of its A3/A4 notes early. It intends to pay off all but c£100m of its bank debt prior to the Unique amortisation starting in 2014E, aided by either high value alternative use disposals or sale & leasebacks.
“In 2014E, after assuming minimal disposal and zero sale & leaseback activity, we estimate Enterprise Inns should generate £55m of excess cash after debt amortisation, equivalent to 16% of the company’s current market capitalisation. We expect the company to use this to repay a £60m corporate bond that matures in 2014. Of the other £1.125bn of corporate bonds, the £600m that matures in 2018 should be refinanced.
“Enterprise’s debt service costs should remain stable at c£145m pa over the next 10 years, by our estimates, with interest falling and amortisation rising. Provided this bond debt reduction continues to be paid out of cash flow, Enterprise should generate substantial equity value through debt reduction over this period (particularly in comparison to the company’s current market capitalisation).”
Jack says that Greene King’s debt position is forecast to fall by 2-3% pa provided the company makes no further acquisitions. He says: “With debt reduction matching bond debt amortisation, we expect Greene King’s bank debt to remain stable. Greene King’s bond debt service costs step up to £111m (from £103m) in 2014E. Unfortunately, this is largely due to a £6.2m increase in interest costs rather than higher amortisation. Thereafter, bond debt service costs should be stable for the next 20 years.”
Marston’s debt position is forecast to remain static. Jack says: “As a result, we expect securitised net debt to fall by £21-24m pa (from £1bn, excluding c£60m of cash) with bank debt increasing similarly. We estimate bank debt to be c£165m as at September 2012 versus a bank facility of £257m. With the new-build programme performing strongly, management’s priority is rightly to reduce net debt/EBITDA by growing EBITDA (rising at 5% pa), whilst maintaining a stable debt position.
“Growing EBITDA is increasing cash interest cover from 2.8x and cash fixed charge cover from 2.6x. Bond debt amortisation should remain modest, at under £30m pa, until 2018 by which time we expect Marston’s to drive up EBITDA.”
M&B’s debt is forecast to fall, broadly in line with the company’s bond debt amortisation schedule. He says: “Our forecasts assume that the company starts paying dividends during 2014E
(2013E's final dividend), after which total debt reduction should just trail bond debt reduction, by our estimates. M&B should have c£250m of cash sitting outside its securitisation structure, which we forecast to remain stable.
“A combination of innovation, rising service standards and self-financed expansion should enable M&B to increase EBITDA by 10%-plus over the next three years, resulting in net debt/EBITDA falling below 4x. Due to this growth in EBITDA and a strong ex-bond cash position, M&B should have no trouble dealing with slight increases in debt service costs over the next nine years.”
Jack says that Punch Taverns is currently paying £20m pa (net of cash tax upstream) to support its
Bonds and can pay this out of group cash, which should currently be at c£90m.
He says: “We forecast Spirit Pub Company to generate excess cash flow each year with the rebranding, IT systems roll-out and dividend all paid from internal cash flow. Spirit Pub Company’s major capital expenditure programmes should be complete before bond debt amortisation commences in 2014E. This should enable excess cash generation to grow, allowing the company to retire bond debt from cash flow. Spirit also has £77m of cash and bonds at group level, providing it with additional flexibility to become acquisitive.”
