The outlook for 2010

To excuse a far too often quoted pun, 2010 could well prove to be a year of two halves. We believe that the stronger companies will exit 2009 at better run rates than many currently predict. As a result they will commence 2010 from a sounder/stronger footing. However, consumers will immediately by impacted by the 1 January VAT rise – this may cause a few problems but we note that a number of operators edged their prices up in December at a time when consumers are historically less price sensitive. The VAT rise in itself we view as unwelcome, but not sufficient in its own right to slam the brakes on recently improved momentum. It’s also worth noting that the comparisons for H1 2010 will be easier than for H2 which should make the first half of next year not as challenging as perhaps feared. Then of course comes the General Election, which must take place before the end of May. Whichever party wins, there will need to be far greater honesty with the public with respect to the scale of required spending cuts (which will have material repercussions for public sector employment levels amongst other things) and indeed the requirement for further tax increases over and above those revealed in the recent pre-budget report. Then it depends on timing; an emergency budget post election that immediately increases the tax burden (perhaps via a further hike in VAT to 20%) coupled with commensurate spending cuts could well impact demand across the piece in H2 2010. If the current year’s spending and tax plans are left intact it will not be until 2011 until the removal of fiscal stimuli combines with a higher tax take to impact. By this time the economic recovery should have gained greater traction. What it means for the consumer of course in that the growth in household disposable income will lag the growth of the broader economy (GDP growth) over the next few years. HOWEVER, its not all doom and gloom! The stronger sector companies responded aggressively to a challenging trading backdrop in 2009 using their buying scale to drive a plethora of discounts – this impacted bottom line margins far less than many sector commentators had imagined. These companies have taken market share and are re-establishing growth momentum in terms of adding new sites from a sounder (stabilised) units sales level. We note that the likelihood of some of the very attractive landlord incentives remaining at current levels is not high. And of course we see M&A activity rebounding strongly in 2010 after the slowest year since 2003. There are a number of companies believed to be (or already planning) looking at the prospect of floating on the stock market, but we believe that some of these may well end up being sold given the recent improvement in liquidity augmented by the fact that interest rates are likely to remain low for some time to come. Nevertheless both Virgin Active and Merlin Entertainment are rumoured to be set for IPO’s in H1 2010; the success of otherwise of these will be key in determining what follows. Either way 2010 will not be a year for setting new highs in terms of valuation benchmarks for new issues. Furthermore, within the private arena we have seen a significant number of debt-for-equity swaps (e.g. Paramount Group, Novus Leisure etc) and it is not inconceivable that the banks will look to exit from these majority equity positions over the next 12-18 months. All told 2010 will not be without its challenges but we see the stronger, well-invested players continuing to move ahead of their weaker competitors and sector interest could well be heightened by the resumption of IPO activity, which could help to at least underpin current valuation benchmarks before a likely stronger recovery in 2011. Greg Feehely is head of leisure research at Altium Securities