M&C Report takes a closer look at the full-year results from Fuller’s, the London-based pub operator and brewer:

Rival Acquisition
Chairman Michael Turner told M&C Report that both Young’s and Greene King had both picked up very good businesses from their respective acquisitions of Geronimo’s Inns and Realpubs. He said: “These were both examples of real entrepreneurs doing fantastically well. Rupert and Jo (Clevely) had done exceptionally well with the Geronimo business.” Turner said that the company had not been interested in Realpubs as they didn’t feel it would fit into its existing estate. He said that there were a number of small operators doing well in the sector that he admired, but that any sizeable estates that he admired had already been “taken out”.

After not making any additions to its estate in the previous year, the company have added four sites to its estate already in the current year. Turner said that the company was “looking all the time” to make further additions to its estate. He said that future acquisitions would focus on sites that have not yet realised their full potential. He said: “These will be pubs and hotels that with investment and careful execution of Fuller’s four pillars can enhance our estate and offer us a higher return than the redevelopment of pubs we already own. Since the end of the year we have already acquired two sites that it believes fits this description. In addition to the White Swan Hotel in Stratford-upon-Avon, it acquired the freehold of The Crown Inn, Bishop’s Waltham which it will reopen later this year following an extensive refurbishment. Turner said: “Our future development spend on these sites will exceed the purchase price. We have also acquired the leasehold interest in The Cabbage Patch, the iconic Twickenham rugby pub, reinforcing our presence in this area.” The company said it was planning significant projects in seven of its existing pubs this year and investment in new tools to aid all of its managers to improve the efficiency of their operations.

Turner said that a recruitment process to replace John Roberts, who resigned as managing director of its beer division in March, was underway and that the company hoped to have a replacement in place later this year.

Tenanted performance and addition
Turner told M&C Report that the company’s tenanted arm had reported a mixed performance in the nine weeks to 2 June. He said: “As a whole it’s performed slightly better than across the same period last year, but it was a mixed bag, with some areas performing better than others.” Turner said that challenges still remain for the estate, especially as pressure on consumer spending continued to intensify. He said: “You need to be offering an experience that your rivals aren’t to bring people out of their homes and into your business.”

Fuller’s believes its tenanted model is already much closer to the successful franchise concepts of Subway and Dominoes than other new franchise agreements hitting the pub market. The London brewer and pub operator said it had no plans to change its current tenancy agreements in the wake of an industry move towards the franchise model led by the likes of Marston’s and Greene King. Simon Emeny, group managing director, said: “If you look at the most successful franchises like Subway and Dominoes, people invest because they know the brand and they get brand support, training and marketing support. There is also a set level of standards that has to be met to carry the franchise. That has been very successful and if you look at our tenants, that is exactly what they are offered. They get a strong brand, access to training, a great standard in cask ale, and investment behind all of that but the pubs must also be fit to carry the Fuller’s branding. We won’t be changing our agreements because we consider we are already closer to that pure franchising model rather than the broader franchise, which is a re-working of how to share the pie.” Emeny added that he ensures there is “maximum cross-over” in best practice from the managed to the tenanted division.

Free of tie
A free of tie option for all tenanted pubs would “decimate” the pub industry — that’s the stark warning from London brewer and operator Fuller’s. Emeny said although he always understood the Business Innovation and Skills Committee would reconvene to review progress, the process remains a “sapping” one which takes focus away from getting more people into pubs. The Committee will decide if they should recommend a statutory code forcing every tenanted operator to offer a free of tie option. The industry would be decimated,” he said. “I think the whole relationship between tenant and landlord would change beyond all recognition. We should never underestimate the mutual interest, especially with Regional Brewers, in keeping tenants in business. “That interest is just not there with free of tie pubcos — they are very hands off and that is when you get real hard-nosed business decisions. People have got be careful about what they wish for.” He added: “If you look at the free of tie pubs and the high street out of our sector, there is evidence that there are many more business defaults than in the tied sector. “The tie means you share in the ups and downs and the landlord has an incentive to keep the tenant in business. Without the beer tie, business failures would be much higher, there is no doubt about it.”

Royal Wedding and Olympics
Turner said that the Royal Wedding had been an outstanding event and had showcased London to the rest of the world in a good light, while also helping to raise morale. He said: “It was an exciting trading day. But performance was mixed, it wasn’t bad but in some areas it wasn’t good. I think on balance the Olympics will be positive for trade, there should be a feelgood factor, which with some good weather, should help performance.”

Excluding the 12 sites where Fuller’s run franchised food operations, the company’s food sales represented 29% of total sales across its managed pubs and hotels (2010: 28%). It said that the 5.1% like-for-like sales growth achieved last year was a direct result of increasing the number of covers as menu prices remained level. Turner said: “Despite our commitment to quality, we managed to hold food cost inflation to 2%, substantially less than UK inflation rate of 4.5%.” The group said that over the past two years investment projects have seen an average increase of 32% in food sales. However, it stressed that this was not done at the expense of its drinks sales.

Accommodation sales represented 7% of total sales in the group’s managed pubs and hotels (2010: 6%). During the year the company refurbished the Wykeham Arms in Winchester, including upgrading the bedrooms during the summer. This led to a 10% increase in room rate in the second half of the year. In April, it acquired the freehold of the 41 bedroom White Swan Hotel, Stratford-upon-Avon. The hotel will be extensively refurbished at the end of the year. This month the company will open 27 boutique rooms at The Drayton Court in Ealing, as part of a £2.6m.

Turner said that the continued raising of duty on alcohol was getting to a point were it will be unsustainable. He said: “This is the next issue the coalition government has to look at. They have been in power long enough now. They can not keep pushing duty up as volumes continue to fall, its not supportable.”

Banking facilities and expenditure
Despite taking the opportunity to increase it committed bank facilities, Fuller’s reduced its net debt by £19.2m to £88.5m, during the year. However, interest expense on these borrowings rose slightly from £4.3m to £4.m as its new bank facility was more expensive than the one it replaced, which had been arranged prior to the financial crisis. Total capital expenditure last year was £12m, which was invested across its existing pub estate with an emphasis on improving customer-facing areas. At the year end the company had £34.5m of undrawn committed funds through its new £100m bank facility that runs until May 2015

Analyst reaction
Douglas Jack at Numis said: “We are upgrading our forecasts by 3%, reflecting the company’s ongoing out-performance. We believe the quality of the business and its track record justify the current rating; forecast risk remains on the upside.

“We estimate that 2% LFL sales are required to offset cost inflation in 2012E; the highest being 5% on utility costs, 4% on food costs and a £0.25m carbon levy. We are upgrading our forecasts by 3%, yet still assume managed pub LFL sales slow to 2% (with margins flat) in 2012E.

“Tenanted pub LFL profits fell 1% in 2011 but we estimate they would have been up 1% without a £0.2m increase in depreciation and repair costs. Further strong investment as well as training and product range improvements are expected in 2012E.

“Despite a strong recent share price performance, we are maintaining our Add stance and raising our target to 725p, from 700p, to reflect our forecast upgrades and ongoing upgrade risk. Given Fullers’ sector leading LFL track record, scope to drive scale economies and successful record for integration, further pub acquisitions could lead to substantial out-performance.”

Lindsey Kerrigan at Panmure Gordon, said: “The group has acquired four pubs during the period; however, we think the lack of a material new site pipeline cannot support the group’s premium valuation of CY 2012E P/E of 16.7x and an adjusted EV/EBITDAR of 9.0x. As such we reiterate our Sell recommendation and 545p price target.

“The group has outperformed our PBT expectation with managed pubs generating £18.1m of EBIT vs our £17.0m, and a lower net interest charge of £4.8m vs our forecast £5.3m. The performance of tenanted pubs and brewing was broadly in line with our expectations.

“Fuller’s trades on a CY 2012E P/E of 16.7x and an adjusted EV/EBITDAR of 9.0x with a yield of 1.9%. We do not think the current valuation can be justified by our forecast earnings growth. We think better value exists in Capital Pub Company (Buy, 172p TP), Greene King (Buy, 520p TP) and Marston’s (Buy, 115p TP). We retain our Sell recommendation and 545p price target, predicated on a CY 2012E adjusted EV/EBITDAR of 8.2x.”

Paul Hickman at Peel Hunt said: “Fullers has again over-delivered against cautious expectations in a tough environment, not only benefiting from the best geographical market in the UK, but also supported by the quality of the retail operation and brewery product. We believe London’s geographical advantage can only improve leading into the Olympics, which together with the increasing balance sheet potential, justify the high PER.” The analyst recommend a BUY for the pub group’s shares.

James Dawson at Charles Stanley said: “Fuller’s strong performance persists and they anticipate the London impact to remain a beneficial aspect. We will review forecast post the meeting, but upgrade PT to 725p (700p), retain ADD. Scope for pub acquisitions remains significant, although the biggest constraint on this may well be availability of acquisition targets given the recent London focused deals secured by some of the competitors.”

Shares in the company rose 9.75p to stand at 645.25p.