Inside Track by Paul Charity
The share prices of the two major tenanted operators have been stuck in the doldrums for at least two years.
The problems that have beset Punch and Enterprise are not directly comparable, but certainly similar - high levels of debt, declining profits, large amounts of tenant support needed for a sizeable bottom-end and questions over the value of their pubs.
Going forward, strategies are broadly similar - a reduction in debt as both companies focus on a smaller, higher quality estate. By the time the process is finished, and if bondholders, in the case of Punch, go along with the plan, the combined estates will be around 40% smaller than at their peak.
Analyst Geof Collyer, at house broker for Enterprise, Deutsche Bank, made a case last week for Enterprise having the better quality estate, marginally, when the process is complete.
The primary challenge, though, in winning a re-rating from the analyst community will need to be addressed.
In the giddy days for the share price of both companies, there was comparatively little by way of questioning about how licensees were faring. Traditionally, the profit pie in the tenanted sector was sliced broadly two-thirds in favour of the pub company and one-third in favour of licensees. There were years pre-credit crunch when Punch earnings ticked up by one per cent or so.
In retrospect, it’s faily obvious that Punch was achieving income growth at the expense of licensees’ share of the cake. The medium term consequence of this is that large numbers of licensee fall off their agreements. Where these pubs are re-lettable, they tend to have lower rents - others have needed to be sold.
Punch itself acknowledged the issue soon after Roger Whiteside arrived as the new tenanted division boss. In April 2009, Whiteside said that its beer income growth had been margin-driven not volume-driven, reliant on its ability to pass on wholesale price increases to its tenants. Rent growth could not be assumed unless pubs were in growth, Whiteside said. And he conceded that without income growth licensees will require a “larger share of the cake”.
Ironically, both Punch and Enterprise will benefit this year from having more than half of their estates where rent increases are linked to RPI, which is now 5.5%.
On the face of it, this is not too dissimilar from the rent regime that crippled the handful of operating company/property company structures of a few years back.
To make a rent increase of 5.5% affordable in the sense of at least maintaining profit levels, a retailer needs to be achieving handsome like-for-like sales increases.
The issue now has investment community resonance. A re-rating of the tenanted operators seems now to require proof that they can achieve operating profits growth that sustainable for licensees.
During the good years of sky-high share values, there was an annual piece of analysis of tenant income, a model profit and loss for the “average” licensee, once a year.
Ironically, as earnings went into negative territory in the past three years, both Punch and Enterprise became more opaque on tenant earnings, abandoning their estimates on average earnings.
As it is, some of the Key Performance Indicators provided by the companies are, quite frankly, meaningless. Take substantive leases - the companies quote the percentage of the estate on these as an indicator of stability. But what is the difference between a Tenancy at Will and a one-year lease (counted as substantive) with a one-month notice period on either side?
City analysts have now become quite vocal about what is required in information terms. Douglas Jack, of Numis Secrities, says: “Not only are index-linked like-for-like rent increases not likely to be sustainable, there is also a risk of a pick-up in the rate of business failures. One can’t justify re-rating Enterprise when it returns to like-for-like profit growth if this is based solely on increasing rents at a time when beer volumes are falling.”
It was a Numis Securities leisure conference two weeks ago that again underscored the information gap within the tenanted sector. Domino’s Pizza, with 650 sites, provides chapter and verse on franchisee income. I’m sure you’ll know the figures - franchisees average sales of £18,000 per week and earn in excess of £100,000 per annum per site.
The requirement to understand licensee earnings properly in the estates of Punch and Enterprise, covering more than ten times that number of sites, is obvious. And unless the companies offer more by way of facts and figures on licensee income, given their recent history, it will be very hard for any level-headed analyst to recommend these leased companies as an investment opportunity.
It is, at the moment, a matter of guesswork as to what is actually happening below the surface at Punch and Enterprise.
Paul Charity is group editor of M&C Report and the Morning Advertiser
