A leading analyst has said that the restructuring at Mitchells & Butlers (M&B) needs to provide some stability and quickly, as the group has already slipped from the top tier of operating performance. Geof Collyer at Deutsche Bank said that the continuing departures from M&B where giving cause for concern regarding operations. He said: “In a hands-on business such as retail, so much change can lead to a breakdown in continuity and have a major impact on the performance of the business. We are now seeing further departures over and above those that left following the restructuring giving cause for concern regarding operations. “The dramatic upheaval at M&B may well in time prove to be just what the group needed, but the changes are still a work-in-progress and are yet to come through in improved operating numbers. We have seen in many retail businesses stumble and without top level hands on management, operational performance can fall apart, even for the strongest business model. “Whilst we do not see the M&B business falling apart, we have seen the group slip from the top tier of operating performance, so the restructuring needs to provide some stability and quickly. In a recent sector weekly (“The Leisure Centre” 31 July 2012) we discussed what we saw as a stalling of the search process for a new CEO. One would imagine having a permanent CEO was a prerequisite to recruiting new people or encouraging existing talent to stay. The lack of a clear picture of the intentions of the major shareholders is also a major impediment for new investors – especially since Piedmont has increased its holding by around 15% to 26.3% since it decided not to bid back in November 2011.” Can the dividend be reinstated? Collyer said that he did not see M&B as having a debt problem. He said: “In our view, less than 4.5x net debt/EBITDA and a 90% freehold property asset base supporting long term fixed rate debt is a sound position. However, M&B is not a high growth business, so it needs to reinstate its dividend to provide some yield support. After all, the other major managed pub retail groups are now all paying dividends, and M&B’s cash flows should be better than most of them. “We estimate that the group is generating around £90m a year of free cash flows after about £100m of investment in the existing estate, tax, interest and funding its amortisation schedule, but before disposal proceeds and investment in additional sites. So the dividend payment should be a trade-off between new site development and looking after its investors. “There is a forthcoming pension review announcement due soon, so we would imagine that any board discussion regarding reinstating the dividend will be informed by any further cash injections that may be required. Which may suggest that any formal board recommendation could still be delayed until H1’13 or beyond.” Is the new plan of leasehold investment working? Collyer said that the dilution created by the disposal of the wet-led estate in 2010 has almost been recovered, however, the returns on reinvesting the proceeds have been variable. He said: “Single site lease and freehold acquisitions seem to be delivering as expected (EBITDA ROI 26% and 14% respectively), but the package lease acquisitions have been somewhat disappointing (14%). The group views further brand rollout from here as being via new sites. Given the lower capital cost of new leasehold investments relative to freeholds – and given that the group already has over £3.3bn of freehold property - we would suggest that investors would be happier to see better returns from expanding the leasehold sites and savings some of the cash allocated for freehold investment to reinstate the dividend Can the group dominate the eating out market? The analyst estimates that at least 75% of M&B’s total sales are driven by the desire to eat out. He states that M&B is the largest player in the UK eating out market, with sales over 40% higher than McDonald’s, the number two player, and its EBITA is around 60% greater, yet also estimates that its overall market share is just 2.5%, based on his FY’12 forecasts and ONS data, so the group has “huge scope to take share from less well capitalised players whether the overall market stalls or not”. “Its scale – as the biggest player in the eating out space also means that it is also the largest component of the industry’s sales benchmark index – the Coffer Peach Business Tracker – so M&B is unlikely to outperform this index to any meaningful degree.” Valuation & risk Collyer said: “We value M&B on 10.5x FY’12E EBITA, which includes a 10% discount to take into account the current corporate governance issues. The major upside risk would be the appointment of a new CEO with significant retail experience. We see most of the downside risks to the M&B story as operational, notably: (i) a failure of the eating-out market to recover from recession and further cost pressures, or (ii) greater top line decline caused by a more economically sensitive consumer next year. 5% off the top line would negatively impact our EPS forecasts by over 8%.”