Leading City analyst Geof Collyer has recommended a sell regarding Punch Taverns, saying the soon-to-be-demerged managed division of Spirit is years away from being as profitable as its peers. Collyer, of Deutsche Bank, said: “We are a step closer to demerger [due this summer] and a step closer to showing the more than significant premium that Spirit would be trading on, were it separated now. Given the history of this estate, we think there is no way that it should be trading on a 50% premium to its peer group – which is what we believe is implied in the current share price. We see Spirit taking years to achieve the level of profitability required to play catch-up, and the peer group would not stand by and let it do that. “The more stable performance of the managed retail business helped to reduce the EPS impact of the still-declining tenanted and leased division. After deducting the benefit of the increase in onerous lease provision, New Spirit’s edita was actually down -1.3% in H1. “Given that around half of the managed estate has had significant investment in the recent past, we would not see this as a particularly auspicious start. Management stated it was on track to meet full year expectations. We have retained our broadly consensual forecasts.” Collyer highlighted Spirit’s onerous lease provision (OLP), which increased from £8m in H1 2010 to £10m in H1 2011. “The OLP grew by 25% to £10m in H1, and is scheduled to be £18m, (+20% for the full year). Stripping out this provision benefit, the ebita growth was half that reported at +6%, with only 23 bps margin gain as opposed to the 80 bps reported. This is closer to our own forecast. In H1, the OLP accounted for 37% of the reported ebita. For the full year, we estimate that it will be around 28%.” On the tenanted and leased (T&L) division, Collyer said: “The T&L business was around 3-4% below our expectations, with further margin erosion, driven in part by machines and rental income falling by more than the drinks sales. LFL net income was -7%, but on an improving trend. “Licensee support was stable at £2m per month, and is likely to remain flat year-on-year. We recently adjusted our Enterprise Inns’ forecasts for the same outcome – i.e. flat. Collyer said that by putting both businesses together, overall revenues in the demerged Spirit would be +7%, with edita up by only 3%. “Adjusting for the OLP benefit, the ebita, ex-OLP was actually down 1.3%, with a 20 bps fall in operating margin. “The bulls will point to the upside opportunity here – and we agree that there is one. However, we would argue that the quality of the P&L is also being fundamentally undermined by the masking of major losses by the OLP. It is equivalent to almost 21% of the reported ebita of the combined Spirit managed and leased in H1. And it is helping to mask the fact that actual profits went down, despite half of the managed estate having had significant investment recently.” Collyer added: “We believe that there is potential upside in Punch, but maintain our view that it will take some time to extract - maybe three to four years. This assumes that it can successfully reach an accommodation with the bond markets. This brings with a degree of uncertainty over the timescale by which an equity value can be delivered. “Until the market can see a definitive route that takes Punch away from defaulting on its securitisations, there is little chance that a positive equity value will be ascribed to it. “We see potential for growth in Spirit, but because of its history over the past decade, and inspite of recent improved operating trends, we see a discount to the peers as an appropriate valuation until it can prove that it can perform in line or better. Given the current valuations of the peer group, this implies a significant discount to the current share price. As a consequence of these combined factors, we rate the shares a Sell.”