M&C Report takes a closer look at today’s half-year results for Enterprise Inns, the leased and tenanted pub operator:
New leases
Enterprise operates 2,265 agreements that are either free-of-tie, or with no share of income for the company, on gaming machines. In addition, there are 4,181 free-of-tie agreements on wines, spirits and minerals. The company outlined the proportion of new agreements since 1 October 2010 that were free of tie across different products: packaged beer, 29%; guest ale, 11%; cask ale, 4%; wines/spirits, 38%; minerals, 32%. In total 95% of new agreements receive discounts. There were also 94 completely free-of-tie agreements. “Quite simply we are prepared to negotiate almost anything with almost anybody,” said chief operating officer Simon Townsend.
Code of practice
In total, 160 tenants and lessees declined to recognise or accept the new code of practice, although there was a 97% take-up in Enterprise’s substantive estate. Townsend said its new code, introduced in October 2010, has “undeniably raised the bar for new entrants in a positive way”.
Licensee earnings
Based on its most recent assessment, Enterprise estimates that on average its licensees have the potential to earn £45,000 per year (down from £47,000 in 2008), including a notional £10,000 for the provision of accommodation and “related benefits”.
Fewer pubs on substantive agreements
Chief executive Ted Tuppen said the extra pre-entry training and business planning requirements by its new code of practice has lengthened the time it takes for a licensee to sign a substantive agreement. As a result, the number of its pubs let on such agreements fell from 89% at 30 September 2010 to 87% on 31 March 2011 (representing 94% of net income). Tuppen said: “I’d be pretty disappointed if [the proportion] isn’t about 90% by the year end,” adding that the “challenge” for H2 would be to put another 250-300 pubs on the agreements. The company “continues to enjoy a strong pipeline of applicants” attracted by the “improved flexibility” of its lease and tenancy agreements, while stricter pre-entry requirements, particularly in respect of assignments, are having a “positive effect” on the quality of its licensees. Meanwhile, 61% of substantive agreements have RPI-linked rent.
Occupancy
Currently one fifth of Enterprise pubs are occupied by “relative newcomers” every year. These pubs only produce 11% of sales across the estate, “clearly highlighting the growth potential,” Townsend said.
Tenants’ survey
A recent survey of Enterprise licensees’ attitudes found 82% were satisfied with their relationship with the pubco and 83% with their relationship with their regional manager. In addition, 75% of licensees regularly use Enterprise’s promotions package.
Sale and leaseback
The sale and leaseback programme is “now largely complete”, Tuppen said. In total 71 high-value pubs, mostly in London, were sold in the sale and leaseback programme both at auction and in small batches to investment companies during H1. A further 34 were sold in April and May, bringing the total for the current year to 105 and making 176 overall, at an average rental yield of 6.5% and raising £247m. Chief financial officer Neil Smith said the programme has “largely served its purpose but remains open to us as a mean of cash generation”.
Lease surrenders
Townsend said that while the number of lease abandonments and breaches has reduced, the number of lease surrenders has increased. He described it as a “dignified” way of parting company with a tenant who has run into troubles while enabling the company to re-let the pub.
Disposals
With 212 pubs sold in H1 for £47m, representing a £9m profit on disposals, the company expects to sell around 500 pubs across the full year, falling to around 150 per annum after that.
Tenant support and costs
Support increased from £7m last year to the current level of £8m, spread across 500 to 600 pubs. Smith said these were “necessary to enable our publicans to trade during difficult trading conditions”, particularly over the Christmas period, and deal with increased costs. In total, the 380 rent reviews completed over the period resulted in an average reduction of 1.6%. Tuppen said licensees put rising costs ahead of consumer confidence as their greatest business concern, and the company listed some of the costs increases over the past three years: beer duty up 35%; gas and electricity bills up 23%; water bills up 8%; and business rates up 12%. Overheads per pub increased by 12% to £121,000 between 2008 and 2010; total turnover in the period was up just 5% to £346,000.
Investments
Enterprise has identified 1,000 sites for investment in the second half of the year; £30m was spend on 800 schemes in H1. Townsend highlighted three pubs that had benefited from investment in the period: firstly, the Tivoli in Cheltenham (£510,000 investment, average weekly turnover from zero to £17,000); the Bull in Sedbergh (£215,000 investment: turnover from £1,000 to £6.000); and the Cross Hands in Bristol (£270,000 investment; turnover from £3,000 to £12,000).
Benefits of Enterprise’s southern bias
Currently 42% of its pubs are located in the south and these generated £88m of income, or 45% of total group income - last year the figure was £87m. Income was static in the Midlands and down 2% in the north.
Debt “close to stabalisation”
Drawn bank debt stood at £545m at the end of the trading period, Tuppen said: “We believe that by the end of this financial year [debt] will be £400-450m. We believe that’s a sustainable level of debt for our business.” He said Enterprise’s bankers and advisors all consider that level to be “reasonable”.
Bank facility
Enterprise revealed details of its new forward start facility, which commenced on 16 May 2011. Tranche A, which expires in December 2013, is £419m, while Tranche B (expiring in December 2012) is £206m, with £48m already cancelled. There will be restrictions on dividend payments while Tranche B is being drawn. The facility represents an initial margin of 3.5% per annum on Tranche A and 4.5% on Tranche B.
Spring trade
Tuppen said trade in Easter and across the recent bank holidays has been “probably 20% up” and “trade seems to have continued strongly throughout April and into May”.
VAT reclaim and other tenant support
Townsend revealed that Enterprise had claimed back £5m in over-paid VAT on gaming machines, pending an appeal from HM Revenue & Customs. In addition, it has submitted VAT reclaims for 553 individual pubs. Other help offered to licensees include 678 successful business rates appeals, representing an annual saving of £1.4m. Among the most popular support packages were cellar cooler maintenance (taken up at 2,147 pubs), statutory compliance (2,977), boiler maintenance (2,147) and utilities solutions (1,056). Enterprise’s Buying Group service, which is now 10 years old, is currently used by 5,000 licensees, leading to an estimated saving of £4m per annum.
MPs and the tie
Tuppen was upbeat about the upcoming hearings by the Business, Innovation & Skills Committee (BISC) into pubco reform. “The question of fairness in the tie have been comprehensively assessed by the Office of Fair Trading,” said Tuppen. Pointing to recently developments made by Enterprise, including implementation of free-of-tie or partially free-of-tie agreements, as well as more comprehensive pre-entry training, Tuppen said: “I also believe our end of year report would make pretty good reading. The campaigners will, of course, never be satisfied but the reality is publicans now enjoy greater freedom on agreements.” Tuppen labelled “preposterous” the idea put forward by some campaigners that one side of the agreement can “unilaterally” change terms of the contract. “It’s a step too far,” he said.
Analysts’ reactions
Douglas Jack at Numis issued a Hold recommendation and said: “H1 PBT fell by 14% to £74m (vs. our forecast of £73m). Supported by H2 starting well, we are holding our consensus-in-line forecasts which assume 3% PBT growth in H2. We expect uncertainty caused by next months’ BISC Report to limit short-term upside in the shares.
“Aided by 212 tail-end pub disposals in H1 for £47m, average net income improved from -3% in H1’10 to flat in H1’11 (-1% in Q1 to +1% in Q2). Our 2011E forecast assumes c.1% average net income growth over the full year.
“LFL net income remains at -2% for the substantive estate (87% of pubs; 94% of income) with support costs up from £7m to £8m (due to difficult trading over Christmas) helping bad debts to fall from 0.3% to 0.2% of turnover.
"LFL rent and beer volumes were not split, but the former should have outperformed, boosted by RPI (averaging 5.0% in H1) as over 55% of pubs are on index-linked rents. We expect management to justify higher rent by reference to £30m of investment in H1, better recruitment, training and non-tied purchasing as well as an estimate that its publicans have the potential to earn £45k pa, including a £10k accommodation benefit.
“In 2011E, we expect ebitda to fall by 8% versus an 11% decline in net debt, implying 9% equity upside over 12-months if the company holds its 9.0x EV/ebitda rating (followed by 8% upside in 2012E). The upside risk is a re-rating caused by estate upgrades leading to growth; the downside risk is political interference undermining the business model.”
Issuing a Sell recommendation, Paul Hickman at Peel Hunt said: “Enterprise Inns has taken a measured approach to the implications of the credit crunch three years ago. We believe it is still too early to look for a generalised consumer upturn, and Enterprise, still dealing with more debt and more pubs than it wants, is not positioned to overperform in the meantime.”
Simon French at Panmure Leisure issued a Buy recommendation.
“H2 has started well and management expects to deliver FY results in line with its expectations, although we expect consensus PBT expectations may fall c2% from the current c£165m. In our view the stock is inexpensive, trading on a CY 2011E P/E of 3.6x and an adj EV/ebitdar of 8.8x. Given the asymmetric risk profile, we retain our Buy recommendation and 110p price target,” French said.
“Enterprise has reported £74m PBT (10.8p EPS) compared to consensus expectations of £77m PBT (11.2p EPS), and our forecast of £79m (11.4p EPS) Most of the difference is attributable, in our view, to a £1m increase in tenant support YOY and slightly higher than anticipated lease charges.
“Whilst overall average income per pub was flat, encouragingly growth of 1% was achieved in February and March. There was significant regional difference with pubs in the north c-2%, the midlands flat and the south +2%. LFL net income per pub for the period was c-2%. Net debt fell c£175m to c£3.1bn, in-line with expectations aided by the disposal of 212 pubs for £47m and the sale and leaseback of a further 71 central London pubs.
“H2 has started well helped by the good weather over the Easter and Bank Holiday weekend.
“Enterprise expects to sell another c290 pubs in H2 which will largely complete its asset disposal programme. The group’s sale and leaseback programme – having raised c£247m – is now largely complete.
“For FY 2011E, we forecast £165m PBT (24.4p EPS) in line with consensus forecasts of £165.0m PBT (24.4p EPS). Management expects to deliver FY results in line with its expectations, although we expect consensus PBT expectations may fall c2% from the current c£165m.
“The stock currently trades on a CY 2011E P/E of 3.6x and an adjusted EV/ebitdar of 8.8x. Our 110p price target is predicated on a CY 2011E adjusted EV/ebitdar of 9.0x, and equates to a CY 2011E P/E of 4.5x. Given the asymmetric risk profile, we retain our Buy recommendation and 110p price target.”
Nigel Parson at Evolution Securities said: “ETI is out of intensive care but its going to be a long convalescence. There are signs of recovery: H1 results were in line with consensus, and ETI is enjoying a good start to H2 despite the consumer-related clouds ahead. We retain our neutral recommendation but the shares could edge forward today.”
