Government plans to introduce a statutory code in the tenanted sector should have a “small negative impact” on Enterprise Inns and Punch Taverns, but overall make “little practical difference” to quoted operators, according to leading analyst Douglas Jack.
However, in a note titled “big noise, small impact”, Jack, of Numis, said that the positive message about the model is “not getting through to politicians” and “until it does, it will be difficult to be positive on the tenanted pub companies”.
Jack issued a Hold recommendation for both Enterprise and Punch at Target Prices of 140p and 10p respectively. He said the statutory code should bring £300,000 to £700,000 of extra costs and “potentially undermine rent, but not to the extent the Government predicts”.
The Government estimates that its proposals will bring a benefit of up to £140m per year to tenants, paid by pub companies, based on a transfer of £7,000 per pub over 20,000 tied pubs. “There are a multitude of possible errors with this estimate,” said Jack.
“First of all, it is unlikely that all 20,000 pubs will rebase their rent. Such an event requires a rent review and there has already been a substantial rebasing of rents over the last five years, during which almost all pub company tied outlets should have had a rent review.
“Also, as we have already shown, the number of reviews that are being disputed to the point of arbitration is immaterial under the current system, for which the voluntary code of conduct is consistent with the core code.”
He also expects the transfer of value to tenants to be much smaller than the £7,000 per pub predicted, saying that, for example, the impact assessment fails to take into account higher rents in the free-of-tie market. It also appears to have made no allowances for tenant support in the model, Jack said.
It also does not reconcile with current compliance of the voluntary code; the fact that nearly all pub company tied pubs have had a rent review within the last five years; and only 0% (Marston’s) to 1.3% (Enterprise Inns) of pub company rent reviews having being disputed to the point of arbitration.
He puts the cost of the adjudicator at £100,000 per year for Marston’s and Greene King and £500,000 for Enterprise and Punch, adding that half of these costs could be saved if the Pubs Independent Rent Review Scheme and the Pubs Independent Conciliation and Arbitration Service are now wound up.
“The number of parallel free-of-tie rent reviews under the Enhanced Code should be much lower than the Government projected, in our view, but the cost per review could be higher. We believe the Government has under-estimated the complications of comparing the tied and free-of-tie model.
“We have adjusted our forecasts slightly for Enterprise Inns and Punch Taverns to reflect these extra regulatory costs, however, after five years of downward rent re-basing, we are not forecasting the impact of the statutory code to be different to the current voluntary code.
“In our view, the best measure of fairness is the effective rental yield that each company is charging its tenants. It is defined as the cost of renting a tenanted/leased pub (beer discount foregone due to tied-purchasing, plus rent, plus tied machine income, less the value of free accommodation) divided by the book value of the pub.
“Using this method, each company’s investment in capex and support is reflected through book values, which are inter-related to the profits and volumes that is partly driven by investment.
“On this basis (after considering all factors; not merely differences in wholesale beer prices), we conclude that the difference in effective rental yield between the quoted tied tenanted/leased estates and free-of-tie Wellington Pub Company is minimal. Given this and the 0-1.3% ratio of rent reviews that go to arbitration, we believe it is too soon to assume much change in pub company profitability as a result of the statutory code.”
Jack questioned the assessment of the costs for larger pub companies under the enhanced code to offer parralel tied and free-of-tie rent assessments.
“This would cost the tenant £200 and the pub company £600 per application, on top of the extra £90/pub pa cost that all tied pubs pay for the adjudicator. As the Government estimates this cost to be £2.5m for the pub companies, it must be expecting 4,200 requests for parallel tied and free-of-tie rent assessments. This equates to 30% of the tied pubs owned by these six companies, even though only 0-1.3% of rent reviews are disputed to the point of arbitration.”
Overall, Jack said the positive news is that tenants will not get a mandatory free of tie/guest beer option, which would “bring dis-economies and reduce investment, support and product range in the sector”.
“The negative news is that despite these obvious pitfalls and the closure rate in free-of-tie pubs remaining twice that of tied tenanted/leased pubs, the BISC chairman (a Labour MP) wants Labour to legislate for the mandatory free-of-tie option should it win the next General Election. This means that regulatory uncertain remains.
“There are issues that need addressing. If all tied tenants should be no worse off than free-of-tie tenants, why should there be a 500-pub threshold for an Enhanced Code, which should discourage ownership and maintain selling pressure? This threshold includes franchised pubs due to their ‘purchasing obligations for beer’ and ‘franchise fees’. The Business Secretary may reconsider this when he realises that Marston’s franchisees pay neither a fee nor for beer.
“We believe estimates on tied versus free-of-tie costs are over-simplistic , utilising questionable data, comparing: wet rent (beer prices) on inconsistent product ranges and dry rent on different levels of asset quality; failing to properly reflect the value of substantial tied support and investment; and failing to reflect differences in risk.
“Overall, we believe the proposals should have a small negative impact. For Enterprise Inns (Hold; 140p) and Punch Taverns (Hold; 10p), it should bring £0.3-0.7m of extra costs and potentially undermine rent, but not to the extent the Government predicts. This would be worthwhile if it could guarantee the end of regulatory uncertainty, but sadly that is not the case.”
