M&C Report takes a closer look at the interim management statement from Mitchells & Butlers (M&B), the managed pub operator: Boardroom Interim chief executive Jeremy Blood said uncertainty about the future of M&B’s boardroom makeup, with no permanent chief executive or chairman currently in place following last week’s announcement that chairman Simon Burke is to stand down, is not having an impact at operational level. “It’s there in the background, but it’s not effecting the performance of the business right now.” He said the uncertainty is “clearly a factor in investors’ minds”. Industry sources have suggested that Blood is the frontrunner to take the chief executive job on a permanent basis, but he simply said: “My position is completely unchanged.” Blood rejected the idea of putting initiatives on hold until a permanent chief executive is appointed. “I don’t think that’s necessary. The strategy is really clear. I don’t think there’s merit in pressing a pause button on a business like ours.” Pricing tactics Blood said the company instigated “significant but not dramatic” promotional activity in response to the “stiffer headwinds” in trading over the period that has meant a “more competitive environment”. “We are still, I think, below the benchmark of some other restaurant operators,” Blood added. He said the focus has been on maintaining volumes, with promotions focused on its value pub restaurant brands Toby, Harvester and Sizzling Pub Company. However, he denied there’s a price war in the sector: “I don’t think so. It’s just a bit harder to get people off their sofas”. He highlighted Harvester as one brand that’s “still performing extremely strongly” and said the company has “not lost confidence in the quality of the assets”. Vouchers versus advertising spend Blood said direct advertising is a good investment with brands such as Harvester that have “good brand recognition” among the public. “On other brands we are finding that a direct call to action through vouchering activity is more effective,” he added. Blood admitted that the focus is more on maintaining volumes than brand building. Margins Blood said M&B expects margins for H2 to be slightly lower than the previous year due to cost pressures. Chief financial officer Tim Jones said M&B is still “on track” with its aim of increasing margins by 300bps between 2009 and 2014. He said the current slowdown “knocks us back a bit” but “that’s still the commitment that we’re holding to”. When asked what steps are being taken to increase margins, Jones said: “There are initiatives we are doing to bring down the cost structure of the organisation.” He gave examples of new logistics contracts and a new IT infrastructure. Jones said the company assumes it needs 2% like-for-like growth to hold margins flat, and it will “probably under shoot that next year”. Cost inflation Jones said M&B’s food cost inflation is about 4%, “some way below what the market is”. If oil prices stay the same, up to £10m per year will be added to its fuel prices next year, Jones added. However, M&B’s tactic of forward buying has created a “price lag” whereby recent wholesale price rises have yet to affect the company. Increases in the minimum wage and alcohol duty were also highlighted as key cost concerns. Trading period breakdown Blood said trading at the end of May was “quite weak”, June suffered from poor comparatives with 2010 in terms of the weather and the lack of World Cup trade. He described trading in July as “volatile”. Non-core assets Blood was asked whether the company would consider disposing its non-core assets, specifically the Alex bar business in Germany and its UK franchise division. “There’s no plan to dispose anything, we’re quite happy with what we’ve got,” he said. Blood said Germany is a “more benign environment” for trading than the UK. Regarding the franchise business, he said: “There’s a clear opportunity to focus a bit harder and get a bit more value out of this.” CAPEX Jones said the plan to spend £75m on expansionary capital projects in the current year, with expected returns of approximately 20%, is “unchanged”. However, he cautioned that the company “needs to keep that [plan] under constant review” and he “wouldn’t be afraid” to reign in spending if conditions become too difficult. Breakfasts Breakfasts, now in place at 500 pub restaurants, generate more than £10m of revenue for M&B, Jones said, worth +0.5% on a like-for-like basis. He expects margins on breakfasts to increase once the company gets “more professional” at working out more precise costs and requirements around areas such as staffing and food wastage. Blood said gross margins before wastage are difficult to ascertain for a self-service buffet operation. “I never thought we’ve have a meeting on mushroom wastage but that’s what we had over the last few weeks,” he revealed. Blood said venues that have served breakfasts for the longest time, and have honed their resources strategies, are seeing the highest profits from the offer. More generally, M&B has been focusing on the ability of its kitchens to cope with continuing demands for food volume growth. “I’m very confident to stand by that as the right thing to do. It will help us keep up quality and volumes,” said Blood. Regional split and bottom end success Blood said trade in London is doing “very well” while the north is “suffering”. Overall, value-led sites are benefiting from customers’ willingness to scale down. “We are seeing, right across the restaurant [sector], trading down from full service to pub restaurants.” Blood highlighted the effect of last year’s World Cup on M&B’s like-for-like drinks sales, adding: “The drinks business a bit tougher in the bottom end, and in the north it’s tougher again.” Vintage Inns and Premium Country Dining (PCD) Despite the trend for customers to trade down when eating out, Blood said he doesn’t see M&B’s more premium brands as being “vulnerable”. Price is not a barrier to sales in Vintage Inns, he said, while the higher prices at Premium Country Dining has not lead to a downturn in the division. However, Blood said PCD, which has a number of sites with large gardens, has been hit by the wet weather in three of the last five weekends. Analysts Nigel Parson at Evolution Securities reduced his FY11E ebit estimate by c.3% following the trading update. However, he added: “Notwithstanding short-term trading issues, we retain our positive longer-term outlook and Buy recommendation. “On unadjusted figures, M&B is trading at 10.2x FY11E P/E (7.4x EV/ebitda). We are confident that the group can deliver long-term improvements in its growth trend and margin (better pricing, procurement and mix), although the ongoing boardroom shuffles and weaker short-term trading may weigh on share performance.” Issuing a Hold recommendation, Geof Collyer of Deutsche Bank said trading “looks fine” and the top line is “better than expected”. But he said: “The problem with M&B remains: who is actually running the company, and where is the marginal new buyer of the stock coming from? “Stock is off 12% vs. the FTA All Share over the past month, following the chairman’s resignation, so much of the modest disappointment may be already in the price. “We have downgraded 2011E EPS by just under 5% today, to what the bottom of the Reuters consensus range prior to today’s announcement. Shares look likely to carry on drifting until the boardroom structure is resolved and stability returns.” Doug Jack at Numis said: “Since 14 May, year-to-date LFL sales have weakened from 3.3% to 3.1%, despite benefiting from easier comparatives. “Combined with higher input costs and promotional spend, margins are expected to be down slightly. Consequently, we are downgrading our forecasts by 4% and our target from 425p to 350p.” He said the company underperformed against its peers in the period, with underlying like-for-like sales up 1% since 14 May. “We are cutting our forecasts by 4% (2011E PBT £161m to £155m, EPS from 28.7 to 27.7p, consensus PBT £162m) to assume LFL rise by 2.5% and ebit margins are flat. We are cutting 2012E PBT from £186m to £180m (EPS from 33.9p to 32.8p; consensus PBT £187m). Management’s target of increasing margins by 300bps between 2009 and 2014E now looks stretched. “The 7.6x EV/ebitda rating (versus 8.7x peer group average) reflects the churn of management at board level. Our 350p target values the business on 7.7x EV/ebitda (2012E) versus a current 2012E peer group average of 8.5x. “To rectify the valuation gap, management needs to be recruited/locked in and dividends resumed. The longer it takes to sort this situation out, the greater the chance of executive/operational management leaving. Our stance reflects value only.” Simon French at Panmure Gordon, who issued a Hold recommendation, said: “M&B has issued a disappointing IMS, with slowing underlying LFL sales growth to c1% and margins anticipated to be down c60bps YOY in the retained estate. “Consequently we have reduced our FY 2011E ebit forecast to £295m, and our EPS forecast is cut by 6.1% to 27.4p. We have reduced our target price to 285p (340p) and reiterate our Hold recommendation, but we expect weakness in the shares today. “The group has reported LFL sales growth of +2.8% in the nine weeks to 16 July, broadly in line with our forecast of +3.0%. However, the group estimates the underlying growth trend has slowed to c1% and growth appears to only be supported by promotional activity, which has been up-weighted. Combined with rising food input costs and some unspecified new sales and operational initiatives, the group expects operating margins in the retained estate to be slightly below last year (17.0%). “The group has reiterated its guidance of £75m expansionary CAPEX, and net debt is in line with expectations at c£1.9bn. However, the weaker than expected underlying sales performance and reduced margins are disappointing. We think the market will speculate that boardroom upheaval is finally impacting on operational performance, and we would also add that Spirit finally appears to have become a genuine competitor. “We have reduced our FY 2011E LFL sales assumption from +3.0% to+2.7%, and lowered our margin forecasts by 60bps. We now forecast £294.5m ebit (from £304.6m) compared to current consensus expectations of £301.3m. Our FY 2012E ebit forecast is reduced by c£10m to £309m. Our FY 2011E EPS forecast falls 6.1% to 27.4p and our FY 2012E EPS forecast falls 5.2% to 32.5p. “On our revised forecasts, the group is trading on a CY 2011E P/E of 10.2x and an adj EV/ebitda of 7.6x. Whilst not expensive, the weak trading update combined with the lack of a permanent chairman and chief executive and a concentrated share register means that the stock is likely to trade at a discount to the peer group. “Our revised 285p target price is based on a CY 2011E EV/ebitdar of 7.5x and a P/E of 10.0x.”

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