M&C Report takes a closer look at the results from Spirit Pub Company, the managed and leased pub operator, for the 28 weeks to 3 March. Headline figures Pre-tax profits increased 7% to £20m, led by a 5.6% rise in like-for-like managed pub sales and mitigated by a 4.5% lfl decline in the leased estate. Revenue was £393.6m (H1 2010: £378.1m), with EBITDA up 3% to £70m and earnings per share up 12% to 2.2p. The company also announced an inaugural interim dividend of 0.65p per share. Managed: category performances Drink sales increased 5% in the outlets, with food up 8%; average food mix has increased slightly from c.38% to c.40% of the sales mix overall. Machine income declined by 11% following the move to convert outlets to more family-friendly concepts, said finance director Paddy Gallagher. CAPEX Capital expenditure in the period was £64m, with £56m invested in the managed brands, £2m in the leased estate, £5m in infrastructure projects, and £1m acquiring a pub for conversion Chef & Brewer. Spirit said it has accelerated its investment programme in the managed sites and expects the full year spend to be £85m-£90m. Managed: brand performance Spirit has broken down the performance across its six brands: * Chef & Brewer - 139 sites, seven in H1. Conversions to the brand are now compete, and chief executive Mike Tye said they are “performing extremely well”, averaging 1,000 covers per week with average food spend per head of £11.30. Tye cited a “better service and better menu”, with monthly changing seasonal specials, for example, plus the addition of features such as real fires and handwritten blackboards. On-line booking was also cited - 24% of Mother’s Day covers were booked online - and an active media presence, including 6,200 ‘likes’ on Facebook in two months. * Fayre & Square - 131 sites, 38 in H1. The aim is to covert 155 pubs to the format, with a long term target of more than 250. With an average spend per head of £7.03, Tye said they represents “some extraordinary value for money”. With a food mix of 61%, the sites average 1,600 covers per week. Deals included two-for-£5 desserts and £5.99 for a curry and a drink. * Flaming Grill - 81 sites, 38 in H1. In total 105 pubs are targeted for the concept (long term: 225+), which Tye says has “breathed new life” into community pubs. Average covers per week is 1,100, with average food spend per head at £8.15, at a food mix of 50%. * Original Pub Company - 24 pubs, two in H1. Spirit has identified 80 pubs for its newest brand, which is female focused and trades all day. Food accounts for just 16% of sales, with average covers per week of 300 and average food spend per head of £6.37. * John Barras - 136 pubs, 51 in H1. Spirit has identified 165 conversions to the competitively priced, community pub brand, which focuses on entertainment. The brand has a food mix of 22% and average spend per head of £6.09. * Taylor Walker - 111 pubs, 15 in H1. Conversions to the brand have ended in the short term, with a long term target of 175+ sites. Average food spend per head is £10.40, with 500 covers per week on average. Spirit said there was “no big disparity” in performance across the different brands. Other managed concepts Two new Wacky Warehouses, which are located in Fayre & Square pubs, opened in H1. More than 410,000 children attend a party at “Wacky Party” each year, with 24,000 admissions per week on average. Good Night Inns, its hotel concept co-located with its pub brands, reached 33 sites, with 750 rooms. Average room rate increased 5.8% to £44.84, and direct web booking are up 7.8% year-on-year. Managed: investment strategy In total 156 refurbishments took place in the half year, achieving an average return on investment of more than 25%. The company said 76% of its managed estate has now been invested and branded, with Chef & Brewer and Taylor Walker refurbishments completed and Fayre & Square “close to completion”. “Our remaining capital investment programme will be largely focused on our Flaming Grill, John Barras and Original Pub Company brands.” Gallagher said 2012 represents the peak of its CAPEX spend, and the following year the figure will be “meaningfully lower”. In total, more than 600 managed sites have received investment. Acquisitions Tye has previously said the company could extend to 2,000 sites, and Spirit has stated long term targets for each brand. But Tye today played down the likelihood of expansion in the near future. “I think we will start to acquire individual and small groups but it’s absolutely not the focus for today,” he told analysts. “We are in no hurry. We will do the right thing for value for the shareholders, but there’s no time scale.” Spirit bought one pub in the period, “a pragmatic opportunity that we grabbed”, which has been converted to a Chef & Brewer. Margins and cost savings New supplier contacts negotiated by Spirit are “starting to bear fruit”, according to Tye. Cost savings associated with its IT systems, including EPOS, payroll, yield management and other areas, is set to reach 25%, said Gallagher. Food margins are roughly flat on the previous year, aided by “price increases and better labour management,” he added. Price rise sin the period include 5% on utilities and 19% on business rates. Leased: performance EBITDA for the leased business fell 9% to £21m, with a 3% reduction in pub numbers, although operating cash flow “remains strong”. Performance in its 530 leased pubs was “in line with expectations”, Spirit said, “with the decline driven by rent re-basing and pressure on beer volumes”. Spirit said the decline was partly due to a fall in rental income, with over one quarter of its leased sites set to undergo a rent review this year; rents were typically set five years ago when the market was stronger. In contrast, rent reviews are due at just 6% of its leased pubs in 2013. Leased: approach The firm said: “Our current focus is on stabilising income within the leased business. During the first half of the year the estate was operated on a transitional basis under a management services arrangement with Punch Taverns plc; in the second half of the year we will have assumed full control of the estate and we are already instigating new sales, marketing and pricing programmes to drive income.” Tye added: “I can already see that the reputation of the Spirit leased brand is improving.” Franchise and other operating styles Tye said he expects trials of alternative agreements, franchise-style concepts and retail agreements, to take place in Q3 2012. Spirit said it would “explore alternative routes within our leased operating model to drive further performance and value”. Disposals, conversions and property Spirit said it has identified the 80 underperforming pubs that it wants to dispose of and has converted seven leased sites to its managed brands. “Conversions will continue where they are earnings accretive.” Tye said: “There probably are up to 100 [leased] pubs that can transfer back to managed.” He pointed out that 490 of the sites had been managed previously and added: “It’s quite likely that the top end of these can transfer back.” The company is to commission a report in H2 on the open market valuation of its properties “and will consider moving to accounting for our properties at a market valuation following receipt of this report”. Onerous lease provisions Gallagher said he expects the onerous lease provision to be £13m at the year end, against £18m at the end of the previous year. Spirit has sub let eight sites with onerous leases, sold one and reopened another as a Flaming Grill. Non-underlying items Spirit said non-underlying items recognised in the period including a £19m rebate in VAT on gaming machines in the prior year, a £23m charge for interest rate swap, a £9m gain on the repurchase of debt, and £6m restructuring costs. Analyst reaction Paul Hickman of Peel Hunt issued a Buy recommendation and said: “Results close to our expectation leave the business model continuing in strong growth, beating most of the pub sector. Technical downgrades may create some short-term weakness, and this represents a buying opportunity. “Given the substantial growth characteristics, the shares reflect a buying opportunity at a 20% FY2012E PER discount to Wetherspoon.” A note from Barclays said Spirit is trading in line with its estimations. “The company released a complicated set of H1 results that will require some explaining by the company. PBT was +7% to £20m vs Barclays £20m, prior year H1 PBT adjusted £2m down to £18m. EPS +12% to 2.2p vs Barclays 2.2p. “Results are complicated by £4m downward revision to FY11 PBT due mainly to the removal of £3m pension credit. This means that FY12 consensus PBT forecasts are likely to fall by c£2-3m (reflecting the removal of the pension credit from reported results). “Crucially, however, we expect consensus EBIT forecasts to remain unchanged. Digging further, the company enjoyed £1.7m business rates benefit and £1.6m beer supply contract provision credit in H1 11, neither which have been repeated in H1 12. This means that “underlying” PBT was actually up c36% in H1 (£20m vs £14.7m “adjusted” PBT in H1 11). “Given the complexity of these results, we do not expect the shares to perform well today, but there is ultimately nothing to change our positive stance on the company. Valuation: CY12 PE of 9.5x and EV/EBITDA of 7.4x.”