M&C Report takes a closer look at the results for the 26 weeks to 30 March for Marston’s, the brewer and pub operator, and speaks to chief executive Ralph Findlay.

Expansion and conversions
Marston’s could include Revere Pub Company and Pitcher & Piano as part of its newbuild expansion programme for 2015, Findlay told M&C Report. Four sites were converted to Revere, its unbranded premium concept, in H1 2013, with another, the Curious Pig in the Parlour at Copthorne in West Sussex, opening this month. Marston’s has identified another six for conversion, with one more this financial year and the rest expected over the next 12 to 15 months. “This is a project which is in its early days at the moment. What I don’t want to do is say we are going to have 20, 30, 40 of these by a certain time. We will convert pubs where it’s appropriate,” said Findlay. He said conversions are likely to be from its existing managed pubs, although he “wouldn’t rule out” conversions from the top end of the Leased estate “if that becomes appropriate”. Findlay said he’d look at the idea of newbuild Revere sites. He added: “It’s possible that as part of that 20 to 25 [newbuild openings per year] Pitcher & Piano could be included in there. We’ve pruned the weaker sites and got out of expensively rented leases. Pitcher & Piano’s performance is very strong - average weekly sales are £23,000. I think Pitcher & Piano has got to the point where it has expansion potential.” Finlday added: “If I’m looking at the possibility of Pitcher & Piano and Revere forming part of the new builds that’s likely to be some time in 2015 given the lead time these things have.” Marston’s opened nine newbuilds in H1, with at least 20 expected to be completed this financial year. All would be either Two for One or Milestones, Findlay said. Next year the focus would be Milestone rather than Two for One, with its rotisserie or carvery formats. He said this reflects the target locations for the newbuilds, with more outlets in affluent areas; around half of the targeted openings for next year will be in the south, with one quarter in Scotland (its first Scottish new build opened in the period in Dunbar).

Statutory code
Findlay said he expects the economic impact for Marston’s of the Government’s proposed statutory code to be “pretty limited” and “not likely to be a material issue”. The plan is to apply the code to operators of more than 500 non-managed sites. Findlay said that over the next two to three years, “pretty much all” of its tenancies will be converted to franchise (some will become managed houses). The leased estate numbered 391 at the end of H1 - he said it’s a “very good quality estate”, with average rent at c£40,000 and average EBITDA per pub at c£80,000. The consultation on the code suggests that franchised pubs should also be included. Findlay said: “It’s very hard to see how franchise can be caught up in it, or should be. Franchisees do not pay rent and they don’t buy beer. Really, that’s what the statutory code sets itself out to manage.”

Marston’s has identified 379 pubs for disposal and Findlay said he expects disposals to take place over the next two to three years. He said a number have been sold to supermarkets, and revealed that Marston’s has an in-house team to convert unwanted pubs to supermarket convenience stores for Tesco and Sainsbury’s. A number of pubs are converted to fast food outlets, Findlay said, while a “small number” remain as pubs, “generally” being sold to microbrewers. In the first half, 31 pubs and “similar properties” were disposed of for proceeds of £18m.

Franchise concepts
Asked if Marston’s could apply its managed concepts such as Milestone and Two for One to franchise, Findlay said: “I would say that’s something we are likely to consider but not just yet. The operation of franchise in the pub world, and in Marston’s, is still in its early days. We introduced this in 2009, we’ve covered a lot of ground and we are still learning.”

New chair
Marston’s has announced that Roger Devlin is to be its new chairman from 1 September, replacing David Thompson. Devlin is currently chairman of Gamesys, one of Europe’s largest internet gaming businesses, the sports media group SIS and Porthaven Nursing Homes. In 2012 he was appointed the first independent non-executive director by the Football Association. He was previously chairman of the Principal Hayley Group, the hotel and conference venue operator, and until 2011 served as a non-executive director of National Express and RPS Group. Findlay told M&C Report that in addition to Devlin’s “very broad exposure” to the leisure and hospitality sectors, his background also provides “knowledge of what on-line businesses are doing”. Marston’s also announced that Richard Westwood, currently director of supply chain and commercial operations, is to succeed Stephen Oliver as MD of Marston’s Beer Company; Oliver is retiring from the company in September after 18 years at the firm. Findlay said Westwood was the “natural choice” for the role and is very experienced.

During the period Marston’s pubs were placed in three divisions: Destination and Premium, Taverns and Leased. Findlay said he was “very happy” with the new structure, which he said is more closely aligned to how the estate is operated.

Newbuild: performance
Performance of the new openings is strong, Marston’s said, with revenue ahead of its £26,000 per week target and returns continuing to exceed the target of 16.5%. The company said it still plans to open 20 to 25 sites per year for the “foreseeable future”.

Destination and Premium: performance
The divisions incorporate 301 Destination pub restaurants, mostly under Two for One or Milestone, plus 38 operating as either Pitcher & Piano or Revere. Total revenue increased 8.3% to £154.7m, “reflecting the continued good performance of the new-build pub-restaurants”. Underlying operating profit grew 9.5% to £24.2m and total like-for-like sales were level with last year, with like-for-like food sales up by 2% and like-for-like wet sales 2% lower. “This performance has been achieved through offering our customers value for money and delivering high service standards in a consistent manner,” Marston’s said.

Destination spend
Marston’s said growth in Destination was achieved through increased customer numbers rather than higher prices, with the number of main meals served up 7% in the period. Spend per head on food increased 3%, principally through higher sales of starters, desserts and coffees. “Service standards and customer satisfaction continue to improve and we have seen steady increases in our Empathica customer feedback scores during the period,” the company added.

Premium: operating margin and capex
The firm said it achieved a 0.1% improvement in operating margin, and it expects cost inflation to be “manageable” for the remainder of 2013 with the majority of costs now fixed. Capital investment for the period was £57m, of which £40m was on newbuilds.

Leased: performance
H1 revenues in the Leased arm fell from £28.1m to £26.3m, “driven by the poor weather in the second quarter”. “As a consequence, underlying operating profit was down 5.8% to £13.1m.” Operating margins grew 0.3% in the period to 49.8%. Licensee stability “remains high” at 91% and capex in the period was £2m. Findlay pointed out that 3% of the growth capex is spent in the Leased division, compared to 90% in the Destination arm and 7% in Taverns. He said the focus in the Leased business is to ensure the estate is of high quality.

The division includes 156 managed community pubs and 1,242 tenanted and franchised pubs, including the 379 identified for disposal. Total revenue remained broadly level at £117.2m, “reflecting the solid performance of franchised pubs offset by weaker sales in managed and tenanted pubs”. Underlying operating profit was down 7.2% to £29.8m “due to the weather-affected performance of the managed and tenanted pubs”. Operating margin fell by 1.9% due to the increased mix of franchised pubs that Marston’s said earn higher absolute profits but at a lower margin percentage than traditional tenanted pubs. Marston’s said: “Our intention is to increase the number of pubs operating under franchise agreements over time, initially through converting tenanted pubs and then a number of managed pubs.” Capex in the period was £13m.

Revenue in the brewing division increased 11.8% to £59.9m, which Marston’s said reflects a strong performance in the off-trade. Underlying operating profit was level with last year at £7.5m. Overall ale volumes were up 8% on last year, with bottled ale volumes up 21% and premium cask ale volumes up 8%, and Marston’s said it has grown its share in both the premium cask ale and bottled ale categories. Around 77% of its own-brewed beers are sold to third parties, up 2% on last year, the company said. Marston’s said it has consolidated its position as the market leader in premium bottled ale, with volume grew in take home; bottled ale volumes were up 16% and take home volumes now account for 49% of total ale volumes. “We have achieved strong premium ale performance across the brand range, with volumes of our largest off-trade brand, Hobgoblin, up 4%. Consumers continue to demand beers with genuine local provenance and regional beers. The success of our localness strategy is best demonstrated by our performance in the independent free trade, where we now sell to around 3,500 customers, achieving premium cask ale volume growth of 5%.” Marston’s said operating margin was down 1.5% to 12.5% “as a consequence of the higher mix of sales to the off-trade, which command a lower margin percentage”. Inflationary pressure were mitigated through a combination of price increases and the introduction of further supply chain efficiencies, the company added.

H1 capex was £78.7m, against £59.4m in H1 2012, which Marston’s said reflects its continued investment in newbuilds and franchises. The timing of the expenditure has been weighted towards the first half and it expects full-year capex to be c£120m (2012: £129.8m).

Current trading
Marston’s said the second half of the year has started well, with like-for-like sales growth in Destination and Premium pubs of 6% for the six weeks to 11 May, bringing year-to-date like-for-like sales 1% ahead of last year. Like-for-like profits in Taverns and Leased were ahead of last year, and ale volumes in Brewing were “in line with expectations”. Marston’s added: “The second half year will benefit from an embedded £12m of profit growth. We will see the benefit of higher profits to the phasing of 2012 openings; nine openings in the first half of this year; and at least a further 11 planned in the second half. In addition, we will also benefit from cost savings following the reorganisation of our business. As a consequence we expect to trade in line with our expectations for the year as a whole, and are pleased to declare an increase in the interim dividend to 2.3 pence per share, which represents a 4.5% increase versus last year.”

Sale and leasebacks
Marston’s entered into three innovative long-term lease finance structures totalling £101m in H1, under which the freehold reverts to Marston’s at the end of the lease term. “These agreements offer considerable flexibility at an attractive cost of finance, reduce our reliance on bank facilities, and extend the maturity of our debt without compromising our preference for freehold ownership of our estate,” said Marston’s. “We have received a further £7m in respect of these arrangements since the period end. Market conditions permitting, we expect to undertake further similar transactions in the future.”

Douglas Jack at Numis said: “H1 results are in line with EBIT down 1.5% due to poor weather and PBT down 18% to £27.6m (we forecast £27.5m) due to a higher interest charge. H2 trading has started strongly; we are forecasting PBT to increase 6% (to £93.5m; consensus £94.7m), equating to an underlying growth rate of 16% (pre snow and higher securitisation costs).

“Marston’s has undertaken a £108m sale and leaseback, but with the freeholds reverting back to Marston’s at the end of the 35-40 year term. As a result, the rent is accounted for as interest, at an attractive cash cost of 5.3%.

“2013E’s growth is being held back by an estimated £8m increase in interest costs. However, in 2014E, not only do we expect interest costs to start to fall, but we estimate that Marston’s will have to raise prices by only 1% to offset lower cost inflation. Given this and much easier weather-related comparatives over the next year, we would buy on any weakness.”

Nick Batram at Peel Hunt issued a Buy recommendation and said: “The weather took its toll on H1, but an identified profit bridge to hit full-year expectations, together with improved trading (LFL sales +6% thus far in H2) should see the group make further progress. The shares have enjoyed a re-rating, but this has lagged some of the peers and we consider that there is further to go.”

Simon French at Panmure Gordon reiterated his Hold recommendation and 145p Target Price.

“Marston’s has announced H1 results broadly in line with muted expectations reporting a 17.6% decline in earnings to £27.6m PBT (3.8p EPS) and compared to our forecast of £28.9m PBT (3.9p EPS),” he said.

“The interim dividend has been increased 4.5% to 2.3p. Current trading is encouraging with LFL sales up 6% in Destination and Premium pubs, LFL profits ahead in Taverns & Leased and Brewing in line with expectations. We expect consensus expectations to trim marginally from £95.0m PBT (13.0p EPS) to £94.0m PBT (13.0p EPS) to reflect new financing arrangements.

“Marston’s has effectively undertaken 35-40 year sale and leasebacks on £108m assets where the freehold reverts back to the group at the end of the term (thus enabling it to remain on the balance sheet). In addition Roger Devlin has been appointed as non-executive chairman replacing David Thompson. The stock trades on a CY 2013E adj EV/EBITDAR of 9.4x.”