M&C Report takes a closer look at the full-year results for Spirit Pub Company, the managed pub operator Year ahead Mike Tye, Spirit’s chief executive in waiting, said that “trading had improved significantly over the last 12 months” but said that he believed that 2011/12 would be tougher. He said: “Looking at all the economic indicators, they suggest that household incomes are going to be squeezed further and it will become tougher for the consumer. There will be winners and losers during this period and we have to make sure we are one of the winners.” Succession Tye said that the outgoing chief executive Ian Dyson had left the company in a “better place” and that he was focused on helping management team and making sure there was a “smooth handing over of the reins” before he departs in December. He said: “It was the right time for succession and Ian has definitely left us in a better place”. Tye wouldn’t comment on rumours linking Dyson with the head post at Thomas Cook. Team Tye said the company had made a couple of appointments over the last few months that have strengthen its management and operational team, including the appointment of Paddy Gallagher as finance director. David Crabtree, who stepped down as chief executive of Atmosphere Bar and Clubs earlier this year, has joined the group as operations director for its City and Urban pubs division, while Jonathan Langford, former director of group estates at Marston’s, has become head of estates development. Onerous lease provisions Tye said that the company was trying to be as “transparent as possible” on its onerous lease provisions. It currently has some £79m of onerous lease provisions spread across 124 pubs. Tye said that against 65 trading pubs it had a provision of £17m, while against the remaining 59 non-trading pubs (closed) it had set aside a provision of £62m. As of August 2010 it held a £70m provision, which a further £21m was added. The company has since utilised £18m of that provision, but an interest unwind in the first half of the year added a further £6m to the provision. Pubs handed back A package of 26 pubs from TCG came back to Spirit during the first half of the year, plus a handful of Bar Room Bar sites. However, Tye said that didn’t expect were many more sites from the TCG estate to come back. Branded estate During the year, the group completed 215 refurbishments, which Tye said were achieving “an average return on investment in excess of 25%”. At year end, 61% of the company’s estate had been refurbished. Tye said that focus of this programme had been on the roll out of Chef and Brewer, Fayre & Square, Flaming Grill and Taylor Walker brands. Tye: “We will continue to focus on the development of these brands and plan to refurbish around 200 pubs in 2011/12.” Carvery Tye said the company was considering rolling out a carvery menu option across its Fayre & Square branded estate. The company is currently trialling the option in three of its sites, and Tye said that early consumer feedback had been encouraging. It is thought that the Fayre & Square carvery trial will lead the company to stop the rollout of its Roast Inn, carvery format, which it has so far opened in two Yorkshire pubs, the Hare & Hounds in Menston, and the Sir Jack in Rotherham. Both pubs are expected to eventually be converted to the Fayre & Square brand. Conversions and disposals Tye said that the process of converting 100 leased sites to managed was underway. He said: “Three pubs were converted over the summer and a further six have been identified for conversion by Christmas. In the longer term, we plan to sell any pubs, which are not suitable for conversion and use the proceeds to invest in the managed business and reduce debt. Disposals in 2010/11 generated £29m of cash proceeds. It expects to dispose of a further c.50 pubs during its current financial year. Average weekly take Tye said that the company recognised that in the in the key metrics of average weekly take (AWT) and EBITDAR margin, “we remain behind the best performers in the industry and have set clear objectives to close the gap”. He said: “We have made significant inroads this year, with trading estate AWT up 7% and EBITDAR margin up 130 basis points, an industry leading performance.” Costs On the subject of rising commodity prices and food inflation, which is expected to rise by between 2 and 3%, Tye said: “We will pass on price and therefore margins should not be under too much pressure.” Staff Tye said the company’s key measure of guest advocacy has increased through the year and is now “consistently around 70%, at the top end of industry benchmarks”. Tye said that staff turnover had been reduced by 50 percentage points and inline with the company growing its own talent, it aimed to have “an apprentice in every pub”. He said: “Our staff are incentivised to succeed and we want them to share in our success. The calibre of our staff has improved at all levels.” CSR Tye said that over the last 12 months, Spirit had made significant progress in its corporate social responsibility activity, including the launch of a “pioneering recycling scheme” which has seen the installation of glass recycling units in 83% of the estate and the recycling of 100% of our cardboard. He said: “We have reduced food waste by 4,000 tonnes and delivered an overall reduction in our carbon footprint by 15%, helping to deliver a £6m saving in energy consumption.” Analyst reaction Douglas Jack of Numis said that the company was “out of cash trap” and recommended a BUY for its shares with a target price of 75p. He said: “Full year results are ahead, with PBT up 17% to £48m (we forecast £47m; consensus £46m). With recent LFL sales up 4.8% (food 5.0%; 5.4% drink), we are holding our forecasts, which assume 30% earnings growth over the next two years and a resumption of dividends (yield: 4.9%; 3x cover) in 2012E. In our view, the 6.6x EV/Ebitda(6.8x P/E) rating undervalues Spirit’s growth prospects. “Even though it is fully offset by tax credits, the onerous lease provision (recently down from £83m to £79m) has undermined Spirit’s rating. In our view, the rating also ignores the progress being made in improving management quality (under new CEO, Mike Tye), the brand portfolio and executing strategy, all of which is now driving strong, self-financed earnings growth.” Lindsey Kerrigan recommended a Hold for Spirit’s shares and set a 48p target price and said that further value should be unlocked by the sale of c450 leased pubs. Kerrigan said: “The group is now in a position to upstream cash to the plc from the securitisation which is earlier than previously anticipated. The group trades on a FY 2012E adj., EV/EBITDA of 7.1x and a P/E of 7.1x. Since its demerger from Punch Taverns (Hold, 11p TP), share price performance has been volatile. “The group has made a good start to the new financial year. Helped by the recent good weather, Managed like for like sales in the first eight weeks were up 4.8%. Food sales were up 5.0% and drink sales were up 5.4%. Over the next two years it will convert around 100 pubs from the leased estate into managed pubs. Further value should be unlocked by the sale of c450 leased pubs within the securitisation but this will require bondholder approval. Ultimately, Spirit will therefore be a pure-play managed pub business.” Recommending a Buy on Spirit’s shares, Paul Hickman at Peel Hunt said: “Spirit is on course to improve its ROCE by around 50bps pa. Its re-investment programme, 61% complete, is set to generate double-digit earnings growth for some years, with a 33% dividend distribution, is adequately financed and managed, and we believe the shares do not merit their discount against the peer group.”