FINANCE: Down but not out

The economy is stagnant, inflation is rising, the cost of raw materials is soaring, sterling is falling, two high-profile drinks firms have fallen and the summer weather is abysmal. But it’s not all doom and gloom for the drinks trade…

Can it get any worse? The CBI reckons it significantly underestimated the depth of the downturn the British economy is facing; the Bank of England says the economy will not grow at all over the next year or so; inflation is 4.4% and heading north of 5%; the cost of raw materials has soared by 30% in the past 12 months, while the prices producers have been able to charge have gone up by only 10.2% – production margins are being squeezed heavily. To add to the woes, sterling is falling rapidly and Britain’s main export market, Europe, is shrinking.

In the drinks sector, the credit crunch has taken two high-profile victims. Cain’s, the Liverpool brewery, failed to secure bank backing to cover its debts and Food and Drinks Group, the parent  company of the Jamies wine bar chain in the City, fell into administration after it too failed to secure funding. The company, which had 28 bars, had net debt of £9 million in 2007, equivalent to 93% of shareholder funds. Its interest charges were £800,000 last year, or 82% of operating profit.

And just when the licensed trade needed a long, hot holiday season, August was more like October.

But the picture is not one of unrelieved gloom, despite the optimistic factors being heavily outnumbered. The first cause for hope is that the price of oil has slumped from $147 to below $120, bringing down with it the prices of many other commodities that have been the root cause of soaring inflation. What’s more, the spread betters (the City’s bookmakers) reckon oil will be at roughly the present level at the turn of the year. That will help curb inflation, which, in turn, will eventually trigger a much-needed series of interest rate cuts next year.

The second is the stock market itself. Although it fell heavily following the Bank’s doom-laden predictions, it has revived and the general trajectory has been upward since the FTSE100 Index hit a low of 5,150 in July. Although still 18% below last autumn’s peak, the market is recovering a mite of confidence.

Further evidence is that directors are beginning to buy shares. In one week recently, their purchases of their own companies’ shares by volume exceeded sales by a ratio of 13 to 1. That is higher than when the previous bear market bottomed in 2003. The long-term average is 2.5 to 1. If those who should know best about their companies’ prospects are buying shares, then perhaps there are some company-specific rays of hope.

That said, the theory that the stock market reflects future prospects is a generalisation. As one City analyst said recently in a statement of the blindingly obvious: “There will be winners as well as losers after the dust settles on the existing difficult market.” The remark echoed a theme highlighted by the drinks business e-service Finance on Friday – and one for which the evidence is gathering. Since Easter, those pub groups with significant managed house operations have in general fared better than those with predominantly tenanted estates.

As one-man-bands, tenants have a more difficult time in downturns. Managed houses provide daily sales data to head office, so trends are more easily spotted and addressed. In addition, tenants usually have proportionately fewer financial resources with which to attract custom, including central advertising and marketing budgets, as well as brand promotional events, and, of course, increasing and improving the food component in their offering. Bigger, well-located managed houses enjoy more swift-footed managements. This does not mean that tenants have lesser abilities but by the nature of their businesses, they are often less flexible.

But flexibility will be a crucial assets if many smaller, tenanted pubs are to survive the consumer spending pinch. The widely respected forecasting house, Capital Economics, says that the credit squeeze, the deteriorating house price market and the rising rate of inflation mean that real consumer spending (ie after allowing for inflation) “will at best stagnate next year before starting to recover in 2010”. With costs rising on virtually every front, retailers, and publicans in particular, face more than a year more of already tight margins being squeezed further. Capital Economics also predicts: “The downward trend in the share of spending on alcohol and tobacco is set to continue.”

A less sombre note for publicans is Capital Economics’ projection that pensioners and low-income households will be the hardest hit by the squeeze on disposable income. Conversely, that means that the young (the freest-spending grouping of pub-goers) will be the least affected because “proportionately they spend less on food and energy and are most likely to benefit from falling house prices”.

There is a sting in the tail, however. Capital Economics says that the risk to its forecasts on consumer spending “lie primarily on the downside”. It’s not going to get any better for many months yet, even for the fleet of foot.

db © September 2008