FINANCE: Is it panic time for pubs?

Trade in pubs is weak and outlets are closing in record numbers. Things are likely to get worse before they get better, so is it all doom and gloom for the pub game? No, if one is selective, now could in-fact be the perfect period to invest in pubcos

What a difference a year makes. What appeared to be a local squall in America turned into a economic whirlwind; very few spotted the credit crunch on their long-range radar. In the past 12 months both London and Wall Street have fallen by more than 20%, declines reflected in the share prices of international drinks groups. Diageo is down by roughly a fifth, as is Constellation; Pernod Ricard has lost about a quarter of its value, as has SABMiller.

London is in a bear market, confidence is at its lowest for 16 years, the housing market is plummeting and inflation is at an 11-year high. So share prices could be heading even further south. Yet, in principle at least, share prices reflect investors’ views about the future.

In that case, Britain’s leisure groups are unlikely to find any respite from the gloom in the months ahead. A number of directors say they have never known trade to be so weak and pubs are closing in record numbers. From the tone of recent headlines and brokers’ notes most businesses might as well shut up shop now rather than suffer a lingering death.

But is that really the case? Profits are still being made and companies are investing further in their businesses. The recent pattern shows dividend payments on the increase.

Giles Thorley, chief executive of Punch Taverns, Britain’s biggest pubs company, started to put matters into perspective in mid-June. “If I ran the business according to my share price, I’d go nuts,” he told The Sunday Times. “The collective profit forecasts for the sector are down in the region of 10%, yet share prices are down about 50%, and some even more than that.”

The implication was plain. Trade is indeed difficult, but in many cases the share-price slump has been overdone because of herd-like irrationality rather than a consideration of the facts. Conditions are worse than at this time last year, but for some trade is not catastrophic.

Punch said recently that its sales were about 3% down. Meanwhile, restaurant groups say business is comparatively buoyant, which should stand in good stead those pub companies that have invested in their food offer.

One leading analyst predicted that JD Wetherspoon would report a 2% decline in like-for-like sales. In the event, like-for-like sales in the 11 weeks to mid July increased by 0.4%, while revenues in the past 50 weeks were 2.2% ahead, beating the company’s own estimates.

Chairman Tim Martin predicted that his operating costs would go up by about £35 million this year due to rising utility bills, wages and higher prices paid to suppliers because of rising raw material and food costs. He expects to have to increase prices by 3-4% just to stand still. Nevertheless, Martin was confident the Wetherspoon chain would emerge stronger from the current problems. He pointed out that this year the company had “financed cash dividend payments of £17m, share buy-backs of £12m and the opening of 23 new pubs to date, with a minimal increase in debt… We remain confident of our future prospects”, he said, “due to our resilient sales performance and strong free cashflow.”    

Meanwhile, Young & Co reported that managed house sales in the 15 weeks to mid July were 5.3% up including new outlets or 3.2% ahead on a like-for-like basis. Chairman Chris Sandland told the annual meeting that he was “positive about the positioning of the business and its resilience” and said he “looked forward to being able to report continued progress in the coming year.” Pointedly, he reminded shareholders that the dividend had doubled in the past two years.

It is worth remembering that Wetherspoon and Young’s trade at opposite ends of the spectrum. Wetherspoon is taking on an “Aldi” image, offering a beer and a burger for £4.59; Young’s unashamedly charges premium prices to its London and Home Counties clientele and has already reinvested the £69m received from the sale of its Wandsworth brewery in new pubs and refurbishing existing outlets as part of a longer-term strategy.

But while Wetherspoon and Young’s both enjoyed well deserved share price rises, Luminar, Britain’s biggest nightclub group, continued to slide to 80% below its peak. The company says this year “is set to be one of the most difficult in recent times”, following a 2.4% fall in sales in the past 19 weeks. That shows it is dangerous to characterise an entire sector.  

As one fund manager pointed out recently, we all like a bargain. That’s why shops hold sales. So it is irrational that when a sector’s share prices are well below what most consider reasonable value, the market’s only reaction is to mark them lower. Yet investing selectively in pubcos today will generate an excellent yield with the prospect of capital appreciation when share prices rise.

db © August 2008