Leading analyst Douglas Jack explores the restructuring solutions put forward by Punch this morning, describing them as favourable and that it should result in an immediate £137m reduction in net debt, without any issue of shares.
Jack said: “We are upgrading our 2014E and 2015E PBT forecasts by 26% to reflect lower interest costs. The proposals are supported by large stakeholders, but approval needs 75% bondholder support.
“It appears that the debt restructuring will be achieved without issuing new shares or altering plans to invest £220m in the estate and sell 1,516 pubs for £435m over the next five years. It also reduces financial risk (new debt profile and covenants) and debt, such that 2014E EV/EBITDA falls from 9.8x to 9.0x (Enterprise Inns: 9.4x). We are raising our target price to 15p and recommendation to Buy.”
In Punch A, PLC financial support should cease; disposal restrictions should be lifted; bond maturity should increase by five years; reducing debt service by £255m over the next five years; and the DSCR and net worth covenants should be removed.
Jack said: “However, the bond will remain permanently cash trapped, with disposal proceeds expected to pre-pay bond amortisation.
“In Punch B, the B1, B2 and C1 tranches (worth £286m) should be cancelled for a consideration of £149m (£56m PLC cash; £37m B cash; £56m of B3 notes). In addition: PLC financial support should cease; disposal restrictions should be lifted; bond maturity should increase; debt service should reduce by £208m over the next five years; and the DSCR covenant should be replace with a 1.1x cash interest cover (forecast: 1.4x).
“Punch should be allowed to upstream 25% of excess cash in Punch B to PLC in return for using £56m of PLC cash to de-leverage the bond. After the transaction completes, we expect there to be c.£15m of cash at PLC, c.£30m in Punch A and c.£25m in Punch B. The Matthew Clark JV should remain under PLC ownership.
“We are holding our 2013E forecast (EBITDA £216m; consensus £218m; guidance £210-220m) which is in line with guidance of core estate average EBITDA falling 3.5%. Guidance is for core average EBITDA to rise 0-1% in 2014E, 1-2% in 2015E and c.2% in 2016E. Our forecasts are in line with this, but we are upgrading 2014E PBT to £49.6m from £39.1m (consensus £42.0m) and 2015E to £49.0m from £39.0m (consensus £37.7m) to reflect lower interest costs in Punch B.”
Jack said that previously, sum-of-the-parts was an applicable metric for valuing Punch, but “the option of breaking up the bond structures has been rejected and is effectively gone”.
He said: “The company has moved from having option value in the bond structures and 18p/share of assets at PLC to having equity value in the B bond (we estimate 5.5x net debt/EBITDA 2014E), still option value in A (c.9x net debt/EBITDA) and c.6p/share at PLC.
EV/EBITDA should be the main valuation metric, in our view. The company appears exceptionally lowly valued on P/E and equity FCF yield. However, with debt accounting for 96% of the EV, we believe EV/EBITDA is a more appropriate measure. Including debt, this is the metric that is used to value transactions, which can then be compared to Punch’s current valuation.
“Disposals should create equity value and support the company’s valuation. Although not completely representative of the entire core estate, it is encouraging that 35 core disposals in the 16 months to December 2012 achieved 15x EV/EBITDA, with 924 non-core disposals at 22x EV/EBITDA. The company targets 14x EV/EBITDA for 429 pubs currently on the market and a cautious 8x EV/EBITDA for 1,087 future disposals.
“Punch has a slight EV/EBITDA discount to Enterprise Inns based on revised forecasts, which is justifiable as Enterprise has made greater progress towards stabilising LFL net income. In the 10 years to 2012, Enterprise’s average EV/EBITDA rating was 10.7x versus Punch’s 10.0x.
“Punch’s share price would be 25p if we valued the company on the same 9.4x EV/EBITDA rating as Enterprise Inns. However, we believe Punch’s current EV/EBITDA discount is fair. The key issue is where are both companies’ ratings likely to go if they return to LFL net income growth, as guided? We expect this to occur; with material equity gearing into the upside.”
