Leading analyst Jamie Rollo at Morgan Stanley has said that the next year could bring further pub industry consolidation as companies seek efficiencies to boost returns in a low growth environment.
He said: With balance sheets largely repaired and equity values having recovered, pub companies find it much easier to fund such deals. Central cost savings and purchasing synergies can boost operating margins by 400bps, and consequent EPS upgrades help the pub sector enjoy a further rerating as the sector attracts new investors.”
Rollo said that a deteriorating economic environment, tougher financing conditions, disparate strategies, and valuation differences could all block potential consolidation.
He sets out the case for moves by M&B, Whitbread and Stonegate amongst others.
He said: “Like-for-like sales have been relatively resilient in the sector, but if we remove the benefit of investment, they have barely been covering cost inflation. Bolting together large managed pub estates can lead to savings in central costs (these range from 4% to 6% of revenues, and perhaps half can be removed) and purchasing synergies (cost of goods c.30% of revenues, with perhaps a 5% saving). This means that savings can total 4% to sales, significant on businesses where operating margins broadly range from 10% to 20%. While small bolt-on deals are likely (there are a large number of small operators reportedly for sale), we think 2013 could see a large transaction.”
Rollo said that Mitchells & Butlers (M&B) has around £400m of firepower (“if we assume it invests its £200m PLC cash and raises a £200m bank loan, effectively reinvesting the £370m Stonegate disposal”), it now has a permanent CEO, and has a track record of buying high quality assets (e.g. from Whitbread).
He said: “In the past, it has been linked to a potential nil-premium merger with Greene King (source: FT 7 October 2011), which could lead to material savings, as well as dilute the influence of M&B’s private shareholders (neither company commented). However, Greene King’s interests in tenanted pubs and brewing, as well as its relatively higher valuation, could both be deterrents for M&B. M&B’s two large private shareholders own 49% of its shares so would be instrumental in deciding if anything gets done. M&B has said there are a number of options for its cash, and that it is more focused on individual additions than large transactions.”
On Whitbread he said: “The company has sold two tranches of pubs to M&B, and we think investors on both sides might welcome another transaction. M&B has a broad brand range and strong pub retail skills with which it could improve the pubs’ performance further, while Whitbread, although it has seen a recovery in trading in its pubs, is more focused on its hotel and coffee shop operations. Whitbread has said its pub estate is a core business and not for sale, though it is not interested in buying more pubs.
“Spirit straddles both managed and leased pubs, and has a single securitised debt structure covering the entire estate, which makes it hard to sell or break the group up. However, the company has improved the trading and profitability of its managed pubs, and is keen to increase the size of this business. With the shares having rerated, the company could feasibly use its equity to do a deal. An acquisition of pubs generating cash outside its securitization net would also help it generate sufficient PLC cash flow to keep the equity dividend sustained.”
“Spirit has discussed selling the Leased estate before, but there have been few obvious buyers for this (although we note Cerberus’ acquisition of Admiral last week). Even if it did exit, it would need to reinvest the cash in other pubs under the terms of its debt structure, and a deal with Stonegate has been discussed in the press, though not confirmed by either party (the Times, 8 September 2012). Spirit has not made any acquisitions since its demerger from Punch, but is considering adding a new funding structure to facilitate investments.”
On Greene King and Marston’s, he said: “The largest regional brewers straddle managed pubs, tenanted pubs, and brewing. In the past there has been speculation about a combination between the two (Daily Mail, July 3, 2009), without confirmation from either party, but they been pursuing increasingly divergent strategies, with Greene King focused on small, bolt-on but high quality acquisitions, and Marston’s organically developing large suburban food-led outlets. Greene King has also been linked with M&B.”
On Stonegate: “The TDR-backed pub company consists of M&B’s high street and late night venues, and part of the old Laurel estate (Slug). It sees upside in wet-led pubs that have been ignored by larger food-led operators, and in the past has been linked with a merger with Spirit (the Times, 8 September 2012, though it has not commented). TDR is one of the few private equity operators still doing deals in the Managed pub industry, the other being LGV (which acquired Novus).”
On Wetherspoon: “The company has made only one major acquisition (Lloyds No. 1 in 2000). It regularly buys single sites and small packages of second hand pubs, but has stated that it is not interested in major acquisitions and prefers to grow through organic additions. The chairman owns 27% of the company.”
On restaurant chains: “As managed pub companies push more into food (which is now 50% of sales at M&B), they are likely to start acquiring more restaurant brands. M&B, for example, owns Browns, and Greene King owns Loch Fyne.
“The restaurant sector is even more fragmented than the pub industry, and there are many private equity backed companies, so potentially a lot for sale. The difficulty is that it is hard to scale up many restaurant brands, and there is an element of entrepreneurialism and even faddism with smaller brands that could be lost once the brand goes national. There is some overlap the other way, with The Restaurant Group, for example, owning a small group of pubs.”
