Punch to reduce debt by £1.3bn

Punch Taverns is enjoying improved managed division margins and should be able to reduce its overall debt by at least £1.3bn in the coming two years, a leading City analyst has reported in the wake of a meeting with Punch executives. Numis Securities analyst Douglas Jack said Punch's fund-raising has undermined the share price, such that it is on half the peer group average (based on EV/ EBITDA) and a third of Net Asset Value.

He said: "The positive catalyst should be announcements on debt reduction in late-August and November.

Improving trading and substantial progress with disposals and ongoing bond retirement suggest that our debt reduction forecasts of £900m in 2009 and £400m in 2010 may have to be upgraded." Jack reportedd that good weather has helped managed pub like-for-like sales to be in strong growth in London. Scotland is also strong, partly due to acclimatisation to the smoking ban, which could have a positive read-across to England next year. He added that despite a big push on lunch/value food, the shift in the sales mix from drink to food is slowing due to improving drink sales.

"This is helping gross margins to recover," he said. "Combined with £7m lower utility costs, higher staff productivity, EBIT margins should increase (not fall 110bps as forecast) next year if sales continue to go according to plan. In the tenanted division, 600 (up from 400) pubs now have value food offers (typically bringing 68% margin on £2.99 retail price).

Jack said: "This is supporting trading, in addition to which the company is making good progress towards complying with the BEC recommendations ahead of the October 'deadline'." He said that company cash flow is strong. Managed pub refurbishment costs are down circa 35% and disposals are likely to further exceed expectations. "The sale of 300 tenanted/leased pubs to tenants should be completed in this calendar year, in addition to a further 700 over the next two years and 120 managed pubs over the next year," said Jack. "Tail-end tenanted/leased pubs are now dominating disposals.

A doubling in the forecast number of disposals could have material benefits: 1) the tail of the estate would be removed, leaving a better quality business with higher average pub profitability. 2) With high exit multiples (13-16x EBITDA), these disposals are broadly earnings neutral initially, but enhancing after retiring bond debt at good discounts. "The bond retirement process is ongoing, with the inclusion of early-amortising bonds further improving bond covenant headroom."