Pubcos ride out the downturn

Shares in publicly-quoted pubcos have had a torrid 12 months, performing poorly compared to the overall market. Caroline Muspratt reports

Between the smoking ban, lower consumer spending and a Budget which has been dubbed the "hangover tax", it's a pretty tough time for pubcos. All pub operators seem to be suffering, and those listed on the stock exchange have seen their share prices take a hammering over the past year.

Regent Inns executive chairman Bob Ivell echoed the thoughts of many pub operators recently when he said Regent was operating in

"one of the most challenging markets I've come across" in his 30 years in the industry.

The recent round of trading updates from listed pubcos has proved pretty dismal, though company bosses, including Punch Taverns' Giles Thorley, prefer to urge caution than be swept up in the doom and gloom. While sales have undoubtedly been hit by the smoking ban, the bad weather of recent months will have skewed results. In summer, drinkers are happy to stand outside for a cigarette, but in winter, they are more likely to stay at home. It is too early to say whether or by how much sales will bounce back. As Punch said recently, "We still hold the view that the smoking ban will have a positive effect on the industry in the medium to long-term."

However, the pub industry is also having to cope with a slump in consumer confidence, as higher mortgage rates and utility bills mean customers have less money to spend.

According to the British Beer & Pub Association (BBPA), an average of 27 pubs a week are being forced to close, a sharp acceleration on the rate of closure in recent years.

BBPA chief executive Rob Hayward says: "Some commentators would have us believe the pub trade has faced a bonanza following the introduction of the Licensing Act in 2005. Nothing could be further from the truth. The industry is facing very difficult trading conditions, resulting in the closure of hundred of pubs across the country."

According to Charles Stanley analyst Sam Hart, managed pubcos with a greater high-street presence appear to have been most affected by the downturn in trading. He says: "The whole sector will probably remain depressed for the time being."

March's Budget heaped more gloom on the pub sector with increased duty on beer, wines and spirits. KBC Peel Hunt's Paul Hickman says: "The historically high level of alcohol-duty increase is further evidence of government's indifference to the economic pressures facing the licensed sector."

He warns that increased prices could make tenanted pubs less competitive, explaining: "Those most immediately affected will be tenants, who at retail level have to bear full wholesale prices from brewers, whereas managed pubs have the option of passing on discounts."

While the bigger listed pubcos are less likely to be affected by some of these issues than their smaller, privately-owned rivals, they have seen their share prices slump dramatically in the past 12 months.

Many, including Punch, Marston's, Mitchells & Butlers (M&B) and Greene King, have lost half or more market value since this time last year. Interestingly, it is those with a greater exposure to the high street, such as JD Wetherspoon (JDW) and Regent Inns, whose share prices have suffered most. JDW's shares are around 60% lower than a year ago, while Regent, which has issued profits warnings, is down about 80% despite being in talks with potential buyers. Even Enterprise Inns, which has quietly kept its head down, is nearly 40% lower than a year ago.

Over that same period, the FTSE 100 has fallen just over 8%, which puts the performance of the pubco shares in stark contrast.

Pubs are not the only

sector to have suffered — the downturn in consumer spending has hit retailers, while the credit crunch has left banks on the back foot. Howard Wheeldon, senior strategist at City brokerage BGC Partners, reckons that banking stocks have shed about 35% to 40% of their value over the past year, while retailers are down about 30%. In comparison, the mining sector is up about 25% and defence stocks are worth about 20% more.

So why have tenanted pub com-panies, which have been traditionally seen as solid, defensive stocks, suffered so much?

Charles Stanley's Hart says: "The whole sector is under a bit of a cloud. The stock market has returned to valuing these companies on fundamentals, and most of them are trading on eight or nine times next year's earnings, a big discount to the market overall." In comparison, pubcos were trading at about 15 times earnings a year ago, when there was speculation that they would strike property deals to unlock value.

Jim Fallon, managing director of corporate finance advisor McQueen, says depressed share prices would normally give scope for industry consolidation. However, he adds: "The banking market remains incredibly difficult and nobody has access to as much capital as they did a year ago. I don't think anybody is going to leverage up as much as they would have done before."

Stock market-listed pubcos ought to perform better, on the whole, than their privately-owned peers, according to Geof Collyer, Deutsche Bank's highly-rated pubs analyst. In a recent note to clients, he said: "The publicly-quoted groups tend to be the better quality companies in the sector — and while we are not trying to suggest that all will perform better than their privately-owned peers, we are implying that scale, better quality assets and fundamentally stronger cash flows should give the quoted stocks a degree of protection not afforded to smaller companies in times of economic slowdown."

It's not just difficult trading conditions that have hurt pubco shares. As Hart points out, "Six months ago there were great hopes that pubcos would be able to release value to their shareholders through their property portfolios."

Now, banks that have been hit by the credit crunch are unwilling to finance any property joint ventures. M&B has been the worst casualty, having to announce a £274m post-tax loss on hedges it took out to cover a planned property deal.

However, Collyer believes that

"the defensive characteristics of

the sector will prove a safe haven in the end."

Crucially, he says the sector is "better managed, in better shape with better assets, better capital discipline and with a better longer-term outlook than either of the past two major consumer downturns."

Pubcos have also been finding new ways to combat falling sales, for instance by investing in food, though many non-essential investments or refurbishments are being delayed.

Regent's Bob Ivell told investors recently: "We have inevitably needed to tailor our investment programme to suit the tough trading conditions, but we are continuing to invest in our brands for the long term."

JDW chief executive John Hutson said: "If it's broke, we'll fix it, but we are holding back on any big investment until we get through the smoking ban."

And while customers are spending less, some pubcos have seen this as an opportunity to launch value food offerings. M&B's rolling out its budget carvery offer, while Whitbread is trialling an all-you-can-eat concept.

Caution is now the watch-word among many pubco bosses, but perhaps this is no bad thing, as operators take a closer look at the quality of their estates, their level of spending and where they can succeed in cutting costs.

Most people in the industry feel that it is difficult to predict when a recovery might take place, but analysts and operators agree that the sector is resilient — and in the long term, sales and profits are expected to bounce back.