Gone for a Burtonwood

Wolves & Dudley has snapped up the 460-strong Burtonwood estate in a deal that strengthens the company's position as a super-regional. The PMA Team reports

Wolves' management had reason to be smiling on results day last Friday. The acquisition of Burtonwood increases the Wolves estate by around 25% to 2,135 pubs and the benefits of the deal for all three of the company's operating divisions ­ managed, tenanted and brewing ­ sent its shares soaring past the £10 mark.

Remember, three short years ago Wolves only just managed to beat off a 513p-a-share offer from Pubmaster. A 60p surge in Wolves shares lastFriday was a sign that the market thought that the Burtonwood deal was a pretty decent counter-blast to arch rival Greene King's acquisition of Laurel's neighbourhood pubs during the summer.

With consolidation the name of the game in an industry where scale is the best defence against ever-escalating costs, the trick is to avoid over-paying. Wolves has picked up Burtonwood for around £155m (including £35m of debt), which works out at £336,000 a pub or eight times earnings after £3m-a-year of synergies between the two companies are taken into account. (By contrast, Wolves has had to pay an average of £465,000 for the 20 tenanted pubs, with an average barrelage of 300, it has bought individually this year)

Well over 80% of the Burtonwood estate is tenanted ­ 420 pubs ­ and situated largely in the north-west, providing a neat geographic fit with the Midlands strength of Wolves. Burtonwood's tenanted pubs produce a highly-respectable £52,500 a year in earnings for the company, only around £5,000 less than Wolves' pubs.

"Burtonwood is very comparable to the better tenanted estates before we make an impact on the business," says Wolves finance director Paul Inglett. Wolves' management believes there is a great opportunity to offer Burtonwood tenants, who are all on three and six-year rolling tenancies, longer leases. Average Burtonwood rent per pub is just £13,300 a year (compared to the Wolves average of £24,200) because tenants are offered "little or no discount" on beer. "There is an opportunity for Burtonwood tenants to have a choice and earn market rates of discount," comments Inglett.

Almost half of Wolves' 1,162 tenanted pubs, where the estate average is more than 280 barrels per pub a year, are now held on 21-year leases ­ where there are bigger discounts on beer on offer in return for higher rents. Despite a declining beer market, volumes supplied by Wolves to its tenants are up 1% while average rent per pub has climbed 9.9%, indicating that better discounts combined with high rents suit both Wolves and its tenants.

Stephen Oliver, who runs Wolves' Union tenanted division, insists that the company had little to fear from the Trade & Industry Select Committee (TISC) examination of the pubco/tenant relationship. Independent rent review panels, clear English agreements and the offer of managed division discounts from suppliers are among Wolves' recent innovations to ensure tenants are treated fairly. This year Wolves produced a guide called Active Ingredients for its tenants, aimed at helping them develop their food offer ­ the company claims 55% ofits pubs are "food-driven". "We're fairly confident about it (TISC)," Oliver says.

A much smaller group of 40 Burtonwood pubs will be added to Wolves' 513-strong Pathfinder managed division. Wolves now lays claim to being the only company opening new-build community pubs. It's planning 20 per year for the foreseeable future, targeting opportunities provided by new housing estates, in particular.

Its new-build pubs ­ invariably trading in Bostin' Locals or Service that Suits formats ­ produce an average weekly take of £15,000 to £18,000. A new Bostin' Local costs around £1.3m to build and produces earnings before tax depreciation and interest (Ebitda) of £250,000 a year. Growth in the all-important food market is thelitmus test of long-term sustainability in the managed sector. Wolves' managed pubs saw a highly respectable 7.8% like-for-like boost in food sales in the financial year.

Food sales now account for 29% of total sales ­ and can be up to 60% of sales in Service that Suits sites. "Food will be a more important component of our business in the future, as refurbished and new-build pubs have higher than average levels of food sales," says chief executive Ralph Findlay. "The reasons for our success include our focus on menu development, high standards of service and hygiene, and a clear value-for-money position in the market."

With regulatory costs exploding in the managed sector in particular, city analysts have been impressed with the way Wolves has increased group operating margin from 17.6% to 22% in the past four years, despite a £23m rise in costs. Greg Feehely, of Altium Securities, described results as "commendable in the face of some pretty relentless cost increases".

National minimum wage rises have drained £16m out of the business, while higher Sky subscriptions alone have added £1m to costs. (A further £750,000 increase is expected to kick in this year thanks to Prem Plus cost rises). All in all,regulatory cost increases have cost Wolves 4.5% of margin in these past four years ­ the company would be enjoying an operating margin of 26.5% without them.

This year, Wolves pushed its margin up 0.5% thanks to a £6m investment in EPoS systems, better purchasing and holding labour costs at the same percentage to sales ratio as in 2003. Not least of the benefits of buying Burtonwood will be the increased distribution for Wolves' beer brands in the long term. (As anybody who has bought a pub knows, it's a brave man who replaces the regulars' favourite brands overnight).

But Wolves is prospering as a brewer on a number of fronts with its Burton site at 90% capacity and Wolverhampton hitting 80% capacity. It begins brewing Draught Bass in February and has new supply contracts with JD Wetherspoon and Mitchells & Butlers. WDB Brands delivered nearly one million pints of beer a day in the on-trade last year. The company claims WDB Brands is now the largest cask-ale business amongst its peer group ­ those who both brew beer and operate pubs.

So there, Greene King!

"There are real opportunities for beer businesses that are truly passionate about ale ­ in terms of brand awareness, beer quality and all areas of service and delivery," says Findlay.

Weathering the ban

Wolves chief executive Ralph Findlay insisted the company is well-positioned to weather the smoke-ban on food-service pubs proposed in the recent Health White Paper for the end of 2008. The size of Wolves' food business would reduce the risk to the company "significantly", he said. "Generally speaking, food and smoking are quite incompatible," he said.

Between 75% and 85% of Wolves' pubs have good outside areas for smokers to use. Findlay also argued that relatively small numbers of pubs would drop their food operation to retain smokers. "I don't think that's going to happen on any great scale," he said.

Meanwhile, Pathfinder boss Derek Andrew admitted that the company was making slower progress in its smoke-ban trial than expected. The company was expecting to have as many as 50 smoke-free pubs by next Easter ­ the number is now put at a maximum of 20.

What the analysts are saying Doug Jack, Panmure Gordon (Buy): "The Burtonwood deal should enable W&DB's growth rate to rise from 6% to 8% and gearing to increase from 81% to 104%. The benefits of this deal are small compared to Greene King's purchase of Laurel, but Burtonwood is agood fit and the possibility of extra synergies (Burtonwood's central costs alone are £4.2m per annum) could lead to upgrades." Target price: 1050p.

Greg Feehely, Altium Securities (Buy): "The estate is exceptionally well-positioned to continue to focus on growing food sales while being able to accommodate its smoking clientele, given the high incidence of well-inves