Fitch Ratings has downgraded the fixed rate notes of Wellington Pub Company, the c800-strong free-of-tie leased pub operator.
It said that the downgrades were driven by further declines in business performance as demonstrated by rising rental arrears, growing numbers of lease forfeitures as well as pubs not let on long leases.
The decline in performance is compounded by limited scope for operational change and structural weaknesses.
It said that the negative outlook reflected the agency's view that Wellington's performance remains challenged by macroeconomic factors such as the uncertainty about the jobs' market, the ongoing change in consumer behaviour, especially affecting wet-led pubs (estimated at c80% of the portfolio), further exposure to alcohol taxation, the continued strength of the off-trade, all coinciding with a large number of leases coming up for renewal in 2013.
The ratings agency said that the lease renewal process remained an area of concern as a significant portion of the portfolio is due for renewal over the next three years - more than 16% of all leases are set to expire by 2013.
It said: “Wellington continues to experience a shortage of experienced and financially strong tenants looking to enter substantive agreements for residential pubs, and as a result, 159 pubs are (as per September 2012 reporting) not on long leaseholds (up from 102 pubs at the same time in 2011), of which 55 are vacant. During the four quarters up to September 2012 73 properties have been repossessed (up from 38 properties the year before) - the highest number within any four quarter period thus far.
“More are expected in the next few quarters, partly due to expiring leases but also rising rental arrears deemed non-recoverable. Almost half of the portfolio is currently (at least in parts) in arrears with its rental payments by more than 180 days (vs. just about one-third last year). If a pub becomes vacant it takes on average 10 months to find a replacement tenant, although some pubs have remained closed for much longer. Consequently the closed house costs (e.g. security, legal, utilities, business rates, etc.) have remained high.”
It said that trialling twelve months (TTM) rental income dropped only mildly by 1.4% with TTM EBITDA down by 2.3%.
Fitch said: “However, there is a risk that if the 63 pubs on temporary agreements closed (or a proportion of them) as well as the 57 leases currently in the process of being renegotiated did not extend/renew and the rental arrears grew further, revenues would shrink, operating costs increase and EBITDA would be further pressured.
“Another area of concern is the state of repair of the portfolio. All substantive agreements are on full repairing and insuring (FRI) leases, placing the obligation to maintain the properties on the tenant. However, with tenants struggling to pay their rent (as indicated by the high delinquencies) the asset manager estimates that about 80% of the portfolio is suffering from some degree of deferred maintenance. Wellington tends to spend comparatively small amounts of capex on currently vacant properties.”
The agency downgraded the group’s £128.4m class A fixed-rate notes due 202 to 'B+' from 'BB'; Negative Outlook and its £33.7m class B fixed-rate notes due 2029 to 'B-' from 'B'; Negative Outlook.
