Punch: Franchise Tenancy, non-core, investments

M&C Report takes a closer look at the H1 results for Punch Taverns, the tenanted and leased pub operator, and reports from its results presentation. Franchise Tenancy Punch said it plans to expand the number of sites on its Franchise Tenancy to c200 by the end of 2014. It expects to have 50 in place by the end of this financial year. Billingham said: "These franchises are designed to drive both Punch and partner profits and reduce the levels of new partner failures. This fully supported open book agreement is attracting new entrepreneurs from outside the sector. It provides them with a newly refurbished pub, best practice operating standards, marketing and pricing support, food and drink menu set up and a range of business management tools." Restructure Billingham stressed the need for a quick resolution to the restructure. "We firmly believe it’s in the best interests of all parties to agree a consensual restructure so it can be launched in the first half of 2013." Non-core estate: segmentation The non-core estate has been separated into two groups: ‘sell now/sell later’ (943 sites) and ‘protect and grow’ (502 sites). Punch said it would be investing in selective protect and grow pubs and re-letting them where appropriate. "We aim to retain high quality partners from the non-core estate by offering partnerships in the core estate where this is possible so that we continue to benefit from their expertise," said Billingham. "We offer the same support to the non-core division that we do for the core division in order to protect the profit generated by these pubs whilst they remain in the estate." The non-core estate comprised 1,445 pubs at the period end and accounted for c20% of Punch outlet EBITDA. The pubs have a much lower average net income per pub at approximately £36,000, Punch said, roughly 50% of those in the core estate. Average profit per non-core pub is c£31,000. They are predominantly small, with low turnover and are wet led. "With limited scope for investment these pubs are more likely to be impacted by the long-term decline in drinking out and as a result are expected in time to generate more value through disposal than retention. Non-core disposals The disposal programme is slightly ahead of Punch’s target to realise £105m of net proceeds in the current financial year, Billingham said. In H1 Punch sold 164 pubs, including 21 pubs from the core estate, together with other assets for proceeds of £55m, slightly ahead of book value and at a multiple of 18 times EBITDA. Like-for-like improvement Billingham expects the core estate to return to growth of between 0% and 1% in the next financial year, then 1% to 2% in FY2015 before returning to a long-term growth rate of c.2% in the 2016 financial year. The core estate net income is expected to decline in the current financial year by between 3% and 4% "as we rebalance rents in the short-term", Billingham said. Trading comparatives are "much more challenging in the first half of this year" but are "expected to improve" in H2 "when the business will also benefit from the recent improvements in letting, investment and food development as well as the increased field team support". Recruitment Billingham said applicant numbers have grown 10% in the past three months. The new Partner recruitment website has been "extremely well received" having attracted c1,200 enquiries in the last three months. Punch said the percentage of core pubs on substantive agreements "remains strong" at 94% and is in line with Punch’s target of having between 93% and 95% of the core estate on substantive agreements. Investments Punch plans to invest in around two-thirds of its core estate over the next five years "focussing on improving the customer environment". The aim is to spend £40m per year on 400 schemes annually for five years. Two thirds of the estate will receive investment over five years. "The increased level of activity in pub investment seen in the final quarter of 2012 has continued into the first half of this year and we have completed investments in 270 core pubs at an average spend of c£100k per pub. This investment is transforming the customer offering in these pubs and the associated trading uplift is expected in the second half of the year." Total capital expenditure in the period was £36m. Full-year capex is expected to be c£50m. Three segments have been identified for investment: high street, community and food-focused. Food development Punch estimates food sales now make up 25% of licensee revenue, up 2.4% percentage points from March 2012 - the target is 35% by 2016. The percentage of Punch pubs without a food offer has reduced from an estimated 23% in 2011 to just 15% at March 2013. Buying Club Punch said the Buying Club continues to grow in popularity, with 55% of our drinks orders now being taken online, up from 35% at March 2012. "A total of 3,300 Partners across our estate are now signed up, an increase of 1,100 Partners over the last 12 months," said Billingham. "Through the Buying Club we are committed to simplifying the administrative burden for our existing and prospective partners and to drive down the cost of running a pub." He added: "We already offer a range of industry leading exclusive offers to our partners and will continue to build on the success of the Buying Club over the next year as we introduce a wider array of services for the benefit of our partners." Support Punch said it increased the size of its specialist field teams in the areas of investment, marketing and food development resulting in a ratio of 18 pubs per field member, down from 20 at August 2012. Billingham said: "The mystery visit programme is being rolled out across the core estate to improve retail standards with every pub having at least one visit by the end of 2013. The programme offers detailed feedback from an independent observer, highlighting operating strengths and development opportunities. Free WiFi has now been rolled out across the estate with over 2,500 Partners signing up. At the same time as increasing our specialist field team support, we have made further head office efficiencies, as we continue to focus on cost reduction as the size of the non-core division reduces." Regional launch managers Punch recently increased the size of its specialist field team support, including the introduction of our new regional launch manager team. Billingham said: "This team provides dedicated support to our partners through the successful launch of every investment, ensuring that the right vision is in place for each pub, supported by detailed launch, promotional and operating plans with a focus on the retail offer to the consumer. The feedback received from partners who have benefited from this new resource has been extremely positive and we are confident that increased support in this area will result in improved trading performance for both our Partners and for Punch." Matthew Clark joint venture Matthew Clark, Punch’s 50% joint venture with Accolade, "continues to perform satisfactorily in a very competitive market", said Billingham. It provided a post-tax contribution to Punch of £2.4m for the period, up from £2m in the comparative period. "Matthew Clark has significant scale in its marketplace as the largest independent drinks wholesaler and distributor to the UK leisure and hospitality industry, with annual turnover of c£700m. Turnover increased by 9% in the joint venture’s last financial year and the business has clear plans for continued growth in market share from which Punch will benefit." Analysts’ reactions Douglas Jack at Numis issued a Buy recommendation at a Target Price of 15p. "H1 PBT fell 21% to £26.2m, largely due to core estate LFL net income being down 4.5%. Nevertheless, we are upgrading our full year forecast by 6% to reflect debt reduction and an expectation of trading trends continue to improve. "More importantly, management remains confident that the debt restructuring will complete by July," he said. "Punch has £82m of cash at PLC, which will become less relevant if the debt restructuring proposal is approved, reducing debt and financial risk in the process. If the debt restructuring proceeds, we estimate that Punch’s share price would be 26p if the company were valued on the same 9.5x EV/EBITDA rating as Enterprise Inns." Simon French at Panmure Gordon issued a Hold recommendation at a 7p Target Price. He said: "Punch has announced its interim results reporting £26.2m PBT (3.0p EPS) down 21.3% on the prior year’s £33.3m PBT (3.8p EPS) and slightly ahead of our forecast of £25.2m PBT (2.9p EPS) (no consensus was available). "The group expects to make further progress in H2 and is on track to meet FY expectations. It says that discussions with its stakeholders regarding its capital restructuring are continuing with the group remaining hopeful it will be launched by the end of June. "The stock’s valuation (CY 2013E adjusted EV/EBITDAR of 10.7x) is largely irrelevant as if a successful restructuring cannot be concluded there will be little equity value left for shareholders; arguably only its shareholding in Matthew Clark worth c7p per share. We therefore reiterate our Hold recommendation."