M&C Report takes a closer look at the H1 results for Spirit Pub Company, talks to chief executive Mike Tye and reports from the analysts’ presentation.
Refining managed brands
Spirit is to trial some significant changes to its brands, which include:
- A smaller, lower cost version of Flaming Grill.
- A more “pub-orientated” Fayre & Square “for more suburban locations”.
- A newbuild Wacky Warehouse, set to be trialed “shortly”, while the Wacky Warehouse offer generally would be modernised.
- For John Barras, there would be a “more flexible approach” to capex and the weighting of the offer between food, drink entertainment and sport.
Acquisitions
Finance director Paddy Gallagher said Spirit has started “actively looking” for more sites. He said it would be a “fairly slow process” and stressed that Spirit won’t overpay. “We will just be looking for sites to complement existing brands.” Tye said: “It’s possible that if a small parcel of pubs comes up we will be interested.” However, he said that Spirit would not be paying a premium for a brand.
Premium trial
Spirit is likely to introduce its new premium concept to another “two or three” sites “fairly quickly” before assessing the possibility of a wider rollout in early 2014, Tye told M&C Report. Spirit opened its trial premium concept at the George in Belsize Park, north London, a couple of weeks ago. Tye said trading has “started really well”. “We set some pretty challenging targets for the guys and they are already up there or thereabouts.” “We always said we would do one just to make sure everything we had in theory was working right. We have a number of sites that we know are next on the list. I expect to add another two or three fairly quickly and we’ll sit back and assess [the impact].” A further rollout could commence in early 2014. Asked if it he believed the concept was limited to London, he replied: “Not at all.” Tye said: “I think until we have a decent number under our belt we don’t know the capacity of the concept.” Asked if premium could become a new segment of the business, Tye said: “At least annually we review the whole portfolio. My view today, and the view of the team, is with the five [brands] we’ve got we can go a long way to get up to 1,200 pubs.” He said the market is “polarising” and there’s definitely more of an opportunity in the premium segment. He said Spirit needs to “keep evolving all of the brands so we don’t lurch from one to the next,” and stressed that other concepts such as Chef & Brewer and Taylor Walker would receive more premium treatment.
Taylor Walker: segmentation
Taylor Walker is to be segmented into two styles: one aimed at tourists, and the other at residents. Tye said the core of the offer would remain the same, but the tourist-focused sites would be more classic in style with a greater focus on traditional British food and drink. The version aimed at residents and workers would be “more contemporary and premium”.
Managed: investments
In H1 Spirit completed 50 refurbishments, with most in January and February “to minimise disruption to the business and drive growth in the second half of the year”. In total 86% of the estate has received investment, with the remainder likely to be completed this FY.
Digital
Tye said Spirit would be moving more of its marketing platform to digital; the company has more than one million guests on its database. The marketing would be more targeted and less “indiscriminate” than it has been previously. Spirit hopes to have a full automated digital market system in place by the autumn.
Guest delivery
Tye said Spirit is “nowhere near our ambition to be consistently flawless” in service levels, and the company needs to “shift the culture to one of absolute hospitality excellence” - cultural change is required “right across the company”. Spirit has been running workshops to engage all staff about what has to be done. Tye said a “hell of a lot of effort” has been going into improving the guest experience. He said in the next two weeks visits will be made to every general manager “talking about what do we need to do”. “The energy is amazing. I sat with a bunch of guys who were clamouring to get on with it.”
Staff training and development
Tye said that three years ago it was “extremely difficult to recruit the best talent into Spirit”, but there’s been a “step change” in the calibre of candidate joining the company. Staff turnover has fallen by 50 percentage points, general manager stability is at 62% and internal succession rates are at about 60% - -the target is 75%. Spirit is to introduce hospitality trainers in each pub, with training “little and often”, with weekly and monthly ‘bite-size’ training.
Managed: costs
Spirit said significant cost pressures driven by increases in duty, raw material costs, the minimum wage and utilities persisted in H1. “We continue to successfully mitigate a good proportion of this cost inflation through ongoing efficiencies at both pub and support centre level and by leveraging our long term supplier partnerships,” Spirit said. It said the efficiencies are supported by the rollout of its new EPOS and back office systems, completed in December 2012. “The initial benefits are starting to crystallise with upside on food gross margin due to tighter control of recipes and a significant reduction in local discounting of which we previously had very limited visibility. Looking forward our focus is on using these new platforms to drive sales through labour optimisation and supporting our general managers to improve the experience for their guests.”
Leased: income
Like-for-like net income fell 2.9% in H1, with like-for-like net turnover down by 1.9%. Like-for-like beer and cider net margin was up by 1%, “an encouraging step towards stabilising performance within our leased estate”. Spirit said overall net income decline was driven by rental income reduction of 6% on a like-for-like basis “as we continued to see the impact of rent rebasing from the large number of rent reviews in the first half of the previous financial year”. The improved quality of the estate contributed to the 8% rise in average net income per pub, which reached £98,000.
Leased: new agreements
Spirit said two other alternative agreements are currently in trial: a premium concept and a retail agreement. Tye said a number of partners have signed up for the former, while the latter has had a “very positive reaction”. He said Spirit would be extending trials of various agreement types in H2.
Leased: support
At the half-year stage, there were rent concessions in place at 14 sites, with an annualised value of £200,000.
Leased: investments
The company said 38 investments were completed in H1, with return-on-investment ahead of the 25% expectation.
Leased: developments
The on-line ordering platform is now present in 44% of the estate. Mystery guest scores are improving and are now at 74%. “Nearly 80% of the estate is set up for success,” said Tye. “I’m convinced that with the right investment behind high-calibre licensees we will make a considerable difference.”
Pubco code
Tye criticised the Government’s proposal to follow through with plans for a statutory code of practice and code adjudicator for the pubco/tenant relationship. He said it’s “premature” to take action when self regulation has not had a chance to be shown to work, and said it “goes directly against the Government’s mandate of reducing red tape and bureaucracy for small businesses”. Tye also labelled it “flawed” and “counter-intuitive”, and revealed that not a single dispute with a Spirit lessee has gone to PICAS in the past 12 months. “The relationship with we have with our won licensees is really strong. It’s a waste of Government time and they could spend it doing other things frankly.”
Capex
Capital expenditure in H1 was £30m, with £18m invested in its managed brands, £6m in the leased estate and £5m in infrastructure projects. Spirit also spent £1m purchasing the freehold of The Talbot in Bristol, one of its existing leaseholds. It expects full-year spend to be between £55m and £60m, with a further 60 managed pubs and up to 60 leased pubs refurbished in H2.
Exceptional items
Spirit incurred exceptional items totally £7m before tax, including a £4m charge relating to interest rate swaps, a £2m impairment charge on non-current assets held for sale, a £2m charge relating to future annual uplifts in property head lease rentals, £1m of restructuring costs relating to changes in our support centre structure, and
a £1m net pension finance income. The tax effect of these items gave rise to an exceptional tax credit of £1m, Spirit said.
Capital structure and cash flow
Cash outflow for the first half was £31m, driven primarily by a working capital unwind due to our seasonal trading pattern and the timing of payments to suppliers, Spirit said. At 2 March 2013, nominal value of net debt was £741m, with a net debt to EBITDA ratio of 5.1 times. Within the Spirit Debenture, net debt was £803m and the DSCR was 1.90 times at half year, “maintaining our significant headroom against our financial covenants”. “During the period we upstreamed £7.5m from the Debenture.
Group cash and bonds, held by companies outside of the Debenture structure, totalled £62m at half year at nominal value. These resources will continue to be used to fund plc cash outflows, invest in the growth of the business and to make dividend payments to shareholders consistent with the policy set out at the time of the demerger.
Our longer term objective remains for the group to reduce the net debt to EBITDA ratio to between 4.0 and 4.5 times and maintain headroom against our financial covenants.”
Pensions
Spirit said the 2012 triennial valuation of its defined benefit pension scheme is in progress and expected to be completed in H2. “Current indications are that there will be no significant change in the level of deficit recovery payments from their current level of £5m per annum.”
Corporate Social Responsibility
Spirit highlights CSR developments in the period. It will soon review its entire supply chain to increase focus on waste reduction with all suppliers. Increased training and field support has helped reduce general waste by a further 5%. Spirit has glass crushers in 100 city pubs, which processed 231 tonnes in H1 that would have otherwise gone to landfill. A trial of automated energy saving equipment within pubs has been extended to a sample size intended to be more representative of the estate as a whole, Spirit said, and “early results are encouraging”. More than £80,000 has been raised for charity so far this year.
Analysts
Douglas Jack at Numis said: “We are holding our FY forecasts (PBT £56.2m; consensus £55.6m), which anticipate 15% PBT growth in H2 (vs 23% in H2 2012), aided by easy weather-related comparatives.”
In terms of its managed estate, Jack said: “We are maintaining our 2.3% full year assumption: trading should have been very strong in April; and weather-related comparatives will be easy for the rest of H2.
“Rebrandings (50 in H1; 60 in H2) continue to beat the 25% CROIC hurdle rate, but capex should soon switch to a “refresh” programme of 250 £25k refurbishments pa over a three-year cycle.
“Managed EBITDAR margins rose 130bps in H1. Higher costs were offset by central cost savings and higher food margins. The latter benefited from better management information from new IT systems. Yesterday, we met the supplier of these systems: the systems tend to pay back in 3-6 months (from gross margin management) with labour optimisation to follow.”
Even though LFL net income fell 4.8% in March, Jack continues to expect LFL net income to be flat in H2 due to less rent-rebasing and easier comparatives.
He said: “Net debt/EBITDA fell to 5.1x (from 5.3x) even though debt rose by £31m, all due to a working capital outflow that should reverse in H2. Cash and bonds at PLC fell to £62m (from £77m), undermined by the working capital outflow, hence we expect PLC cash/bonds to still be £62m at year-end despite the dividend becoming progressive (up 5%) in these results.
“Of the pub stocks, we estimate Spirit offers the strongest PBT growth (10%; 17% prior to reductions in onerous lease utilisation). In our view, this growth, improving trading prospects and c.£70m of cash tax credits are not fully reflected in the valuation (EV/EBITDA 7.4x; peer group average 9.0x).”
Nick Batram at Peel Hunt said: “H1 was tough, and the poor weather in March means H2 has got off to a difficult start. However, there is enough evidence of underlying progress to give us confidence that the group can ultimately deliver. Comparatives become easier from here as well. Given this, we believe the valuation is attractive and we retain our Buy recommendation.
“The progress made in H1 from a bottom line perspective is not what we had been hoping for six months ago, but against a tough trading backdrop there is enough to suggest that the business will ultimately get there. Excluding March (where the weather led to a 4.1% decline in Managed LFL) H2 benchmarks are less demanding. This, together with the improvements coming through from EPOS and backend systems, means that the full-year expectation is still achievable. Given this and the valuation, we continue to believe the shares offer good value.”
Jeffrey Harwood at Oriel Securities issued a Buy recommendation at a Target Price of 62p.
He said: “Spirit reports interim pre-tax profits of £20m, up 3% and exactly in line with our forecast. A better than expected performance in Managed Pubs was offset by a profits decline in the Leased Estate. We are not changing our full year forecast of £56m pre tax.
“March was a difficult month due to poor weather conditions. In the Managed estate, like for like sales declined by 4.1% and in Leased like for like income was down 4.8%, for the four week period to 30 March. Since then we understand that trading in recent weeks has improved markedly.
“We are well placed to perform strongly during our key summer trading period and remain confident of delivering full year expectations.
“On our unchanged full year forecast of £56m pre tax, we consider the shares have good upside on a prospective P/E of 9.6 times, given the outlook for earnings growth. In particular the rating is low in relation to comparable pub companies.”
A note from Citi reiterated its Buy recommendation and 75p Target Price. It described performance in the managed estate as “strong... in the context of the weather and driven by refurbishments and the new EPOS system, which has improved food gross margins”.
“Leased EBIT of £15.9m is below our £17.1m forecast – largely reflecting the above-mentioned support costs, which amounted to around £1m.”
Citi’s FY expectations were unchanged. The note added: “We now assume EBITDAR margins reach 24.0% in FY13 and 24.3% in FY14 as the group continues to close the gap to sector peers (25.0%).
“Although weather has been a drag so far, the fact that the group is still on track is reassuring. Improved weather could drive upgrades (+1% LFL adds £3.0m-£3.5m to managed EBITDA. On 9.5x FY13 PE and 7.6x EV/EBITDA the stock still looks cheap compared to peers on 11.3x & 8.7x respectively.”
