M&C Report takes a closer look at the interim management statement (IMS) from Enterprise Inns, the leased and tenanted pub operator: Performance Although it’s not specified in the IMS, the consensus estimated figure at Enterprise is that net like-for-like income for the whole estate fell 4% in H2, with a decline of 5% in the whole year, said chief financial officer Neil Smith. Net income per pub in the substantive estate fell 3% in the north, against a 5% decline in H1, while in the midlands it was flat (H1: -2%). Chief operating officer Simon Townsend said this was due to a combination of bottom-end disposals and “us working extremely hard to address the trading conditions expected in the north and Midlands especially, those that are wet-led". Disposals: pace and income Chief executive Ted Tuppen said Enterprise’s accelerated period of disposals - selling off around 500 pubs per year - is expected to end after this financial year. “We would expect to return to a more normal 150-200 per year, which we would just regard as normal estate churn.” The company has sold 335 pubs so far this year, raising £69m. It expects to generate about £110m from the sale of around 500 sites across the full year. Disposals were sold for an average of eight to 10 times income, expected to average at around £220,000 per site at the year-end. The sale and leaseback programme, “largely completed” in May, raised £247m from the sale of 176 high-value properties at an average rental yield of 6.5%. The number of pubs held as assets for re-sale decreased from 110 to 85. Separately, just under 100 pubs in the estate are currently closed. Disposals: buyers Tuppen said roughly half of Enterprise’s disposals are for alternative use, for a “whole range of uses”. “We are very much selling one at a time. I think we’ve sold two over the years that have been converted to mosques.” Of those sites that will remain trading, Tuppen said there’s been a notable rise in sales to microbrewers. Lessees As well as letting pubs to managed operators on free-of-tie agreements, Tuppen said a small number of sites have been let for alternative use. “Expect that shift to move gently forward.” Food The food mix in Enterprise’s estate is now 25%, up from about 22% one year ago. Tuppen told M&C Report that it’s a “function of the improving quality of the estate”. “Over the last year we’ve seen quite a change. Part of that is because the pubs we're disposing of are at the bottom end of the estate and don’t have the ability to do food. But I [also] think it’s indicative of pubs recognising that as wet sales are relatively flat, it’s an opportunity for pubs to generate more income.” Tuppen highlighted one Enterprise pub, the Dartmouth Inn at Totnes in Devon, which introduced a £6.95 carvery offer and now sells 320 carveries on Sundays. Tuppen added: “Even if it’s on a relatively minor basis - a pizza oven, something like that - people are recognising that food is part of the offering.” Capex The profile of the capex investments across the estate is changing, said Tuppen. The last three to four years has seen most investments sit around the £25,000-£30,000 mark, but increasingly larger projects of around £200,000 to £400,000 are taking place as “confidence comes back to the market”. “We’ve done a lot of smaller schemes and many pubs are in a pretty good conditions anyway, so it’s nice to look at bigger, more transformational schemes.” Capex spend so far this year is £50m, with the figure expected to be more than £60m for the full year. The figure has remained consistent for the past few years, said Tuppen. Managed tenancy agreement Tuppen revealed that Enterprise’s “managed tenancy” agreement - where the pubco has a greater role in the running of the pub - has now been introduced to around 100 pubs across northern England, the Midlands and a “handful” in the south. It represents a significant roll out for the agreement, which had been earmarked for around 50 sites this summer, mainly in the north west. Tuppen described the agreement as being “generally successful”. “We’ve got sites that were doing £2,000 per week that are now doing £10-12,000, but I’m sure they’re not all like that”. Tuppen said there have been “tweaks” during the trial - known as Project Beacon - around areas such as the food offer, and revealed that the company is looking at the idea of “very gentle branding”. Tenant support Townsend said: “As evidenced from the number of pubs in the substantive estate (88%, up from 87% in H1), the cost of business support has now started to reduce in terms of the number of pubs and the cost. We do expect that trend to continue through the balance of the financial year. We would expect, as we’re coming out of the accelerated disposal programme, for that [sum] to reduce.” MPs Tuppen said it was “daft” to suggest that Enterprise misleads its tenants, in reference to comments made by MP Brian Binley while questioning the Enterprise boss at the Business, Innovation and Skills Committee (BISC) hearing last month. Binley said he had spoken to Enterprise licensees in his constituency who claimed they had been mislead by the pubco about how much they could expect to earn before taking on a lease. “We have no desire to mislead people,” said Tuppen. “We sit in these [committee] meetings and they say, ‘we’ve been told this’, and we say, ‘it’s wrong’. That part of it becomes rather pointless. ‘He said this and I said that’ doesn’t really get us anywhere.” Independent advisors Tuppen promised to “push even harder” to encourage other pubcos to insist that anyone signing a lease or tenancy has taken formal advice. He said Enterprise currently pays £250 towards independent advisors for licensees before they sign an agreement. He said the move would help “defuse” tensions between landlord and licensee, and would be a more productive method that merely giving licensees access to a database of pub running costs. “I’m going to push even harder now saying the industry should make it standard that every publican signing agreement has to have independent advice,” said Tuppen. “I think nearly every [tenanted pub operator] would enforce it. I think there’s an increasing agreement that this may be the answer, but this is at a very early stage.” He imagined a system of licensee-appointed surveyors, accountants or and valuers could operate under the BII or similar body - the BII recently launched its “approved list” of advisors to licensees and pub owners. Analysts Douglas Jack at Numis issued a Hold recommendation and said: “Enterprise Q3 IMS shows a “stabilisation” in trading for the 18 weeks to end July. Whilst it remains “cautious about the underlying economic environment” it expects to deliver full year results in line with expectations. “We are holding our forecasts (PBT £165m; consensus £162m). However, whilst the valuation is undemanding, we continue to expect the shares to be undermined by uncertainty caused by the BISC pub company review. “We have cut our price target from 100p to 50p, although this amounts to a reduction in our target EV of just 7%.” Issuing a Buy recommendation, Paul Hickman at Peel Hunt said: “Although Enterprise is still in the process of strengthening its balance sheet, trading has been stabilised, and the tail is steadily being seen off with disposals firming prospects for refinancing. “At an 80% discount to NAV, the equity is now being priced for failure, and the potential exit from the SmallCap is also in the price. As a result the shares are oversold at 2x FY11E PER.” Lindsey Kerrigan at Panmure Gordon said: “We remain confident that the company is over the worst and that, with average income per pub growing and debt levels reduced, the current share price represents an exceptional opportunity for value investors; the group trades on a CY 2011E P/E of 2.2x. We reiterate our Buy recommendation and 110p price target. “LFL profit growth will take longer to achieve but we believe there is nothing structurally wrong with the group’s pub estate to prevent it from returning to growth. “Our analysis suggests Enterprise’s free cash flow generation will be strong enough to meet all its bond debt obligations, and bank debt amortisation potentially paving the way for a successful c£350m refinancing in c18 months. We are encouraged by the improving rate of decline in industry on-trade beer volumes (H1 - 4.2% YOY) and believe that, if the rate of decline can stabilise at c-4% per annum, then the Enterprise pub estate should be able to generate LFL ebitda growth, given rental income is predominantly linked to RPI. “The stock offers significant upside potential, in our view, as it demonstrates it can service its debt profile and the equity component of the EV increases substantially. We reiterate our Buy recommendation and 110p price target, based on an adj EV/ebitdar of 9.5x.” Nigel Parsons at Evolution Securities issued a neutral recommendation. “ETI is out of intensive care and on the long road to recovery but it’s a view that is not reflected in the share price which has dropped by over 60% YTD,” he said. “We do not envisage this poor performance reversing materially in ongoing market conditions. Enterprise is a stock for deep value investors with a tolerance for share price volatility (Equity = 7% of EV). The share price could double and its EV would only increase by 7%. “At yesterday’s close the stock traded on a PE of 1.9x to FY11E to FY12 and EV/ebitda of 9.0x/8.6x for the same periods. The equity now represents a geared recovery option but with no obvious catalyst.” Shares in Enterprise fell 1.69p (3.83%) to 42.49p last night.

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