The pub sector is in the best shape its been for three decades and it has plenty of scope to grow and take market share as the economy improves, according to leading analyst Geof Collyer in an extensive report on the UK’s pub and restaurant industries.
In the 129-page report called The Chips Are Up, Collyer, of Deutsche Bank, who also predicted a return of M&A in the sector, said pub groups are emerging from the “perfect storm” of recent years in “much better shape”.
“Having survived the smoking ban, above inflation excise beer duty increases and the recession, as well as a more conservative attitude towards leverage, the pub sector has emerged in much better shape, in our view, than at any stage in the past three decades. Despite the significant decline in beer volumes – now 45% lower than 15 years ago – the sales mix of the pub groups is now more geared to growth than a rear guard action on declining volumes.
“The eating out market data suggests that there has been at least nominal growth in spend on food away from home in all but 6 of the past 196 quarters since ONS records began in 1964. We estimate that over 50% of most pub groups’ revenues are now driven by their customers going out to eat and drink rather than just drink. For the major quoted pub groups, we estimate that this is closer to 65% to 75% of total sales.”
Collyer said the market is more fragmented than at any stage in the last 25 years, being split between nine sectors (including the likes of health care, education, “staff feeding” as well as pubs, restaurants and hotels) and the growth in different day-part trading.
“In such a fragmented market, there is ample scope to gain not just share but also to grow as the pub and restaurant sector, and more pertinently, the UK economy emerges into an upswing.
“With real wage growth now expected, the pub and restaurant space is ideally situated to benefit as consumers seek more low ticket, affordable treats – a sweet spot – or should that bedessert, as we are looking at the growth in eating out. We also see many opportunities to break into other day-part trading areas, providing scope for increasing like-for- like sales growth potential, although companies will need to avoid this becoming too dilutive in terms of margins.”
Collyer said he expects to see “scope for a step-up in M&A activity”, not just amongst the smaller players, “but also as the larger groups diversify away from pure pub formats”.
“We see most – but not all - of this deal potential happening amongst the managed pub and restaurant groups. Amongst the Top 200 groups in the pub & restaurant space, we have identified 54 private companies with annual revenues of between £20m to £600m and 87 private companies that have sales below £20m. We see a number of these seeking further development capital, which can come either from traditional banking sources, private equity – which likes good rollout stories – or well capitalised pub & restaurant groups.
“We have seen this kind of activity with the takeovers of Loch Fyne Restaurants, Capital Pub Co, Cloverleaf and RealPubs, all of which have recently joined the Greene King stable as their backers sought an exit rather than fund the next stage of development. These deals for GNK have helped improve ROCE by around 100 bps and delivered better lfls sales and profits growth.
“Amongst the Top 200 groups in the sector, only 16 that are licensed and are quoted on the London Stock Exchange, Full Listing or AIM, accounting for just 14% of the eating & drinking out market revenues.We believe that some of the 131 private companies might like to join them at some stage.”
In terms of potential M&A funding, Collyer said Greene King has “facilities available and the best track record in the sector”. He said M&B could have some cash freed up, subject to discussions pending with its pension trustees (it has yet to reinvest the majority of the proceeds from the 2010 disposals to Stonegate, he pointed out).
Meanwhile, the ratings of The Restaurant Group and JD Wetherspoon “might help them raise equity should they feel the need to make acquisitions, though we see both remaining firmly in organic rollout mode”. “Marston’s M&A track record and its desire to maintain momentum on the new build plan makes it an unlikely protagonist. As for Spirit, a deal merging with another pub group might provide the opportunity to raise fresh funding that could improve its stretched balance sheet – the least conservative in the sector, with c.1.5x fixed charge cover.”
