Brumby: The cost of tenant support

The first year of the smoking ban is now behind us. Comparative pub sales from 2007 should therefore be easier to beat, but has the suicidal aggression of the off-trade, together with the slowing economy, picked up where the ban left off?

And if it has, then what implications does this have for the UK's circa 30,000 tenants and lessees and for the companies that ultimately own the assets that they operate?

Here we offer (right) what we believe to be a typical tenant or lessee's profit and loss for both the current year and year one. There can be no positive spin attached to a 90% profit decline and tenants have bills to pay. While VAT payments and rent bills do not have to fall on the traditional quarter days (end-March etc), they often do, and as straws that break the camel's back go, these are pretty big straws. End-September and end-December might be tricky for tenants' cash-flow and, although both may well be manageable, end-March 2009 might be a tougher proposition.

Hence a number of tenants may require financial assistance from their landlords in order to persuade them not to hand back their keys. The alternatives are limited and, as a marginally profitable pub is preferable to a closed pub, we believe that the pub companies are likely to support their tenants. This will cost money. In the case of Punch Taverns and Enterprise Inns, this cost could amount to £50m to £60m a year if trade is not as bad as it might be and more than £200m per annum if it's as bad as I think it will be.

Cash-flow​

This has implications for pubcos' cash-flows. We believe that operators such as Marston's and Greene King will face many of the same

pressures. However, they have al-ways insisted that they aim to "optimise" rent rather than maximise it in the short term and we believe that they are better positioned to weather the storm.

On the basis of our forecasts for the coming year, the tenant may well find himself in a tight spot. True, the pub represents the tenant or lessee's home and he will be reluctant to hand back the keys, but the desire to pursue a certain course of action (ie, to stay in business) has to be accompanied by the financial wherewithal to do so.

In fact, the tenant may do almost anything to head off handing back the keys, including cutting costs further and trying to buy outside of the tie.

In addition, some debt counselling agencies are suggesting that individuals are borrowing on their credit cards to maintain mortgage payments, but in that direction misery lies. Unfortunately for the pubcos, the tenant may also ask for rent deferrals, reductions, soft loans, or easier payment terms, all of which would impact on profit and loss.

Concern​

We believe tenants have reason to be concerned. They are doubtless hoping for a warm summer and they may get one.

They will also be looking forward to Christmas and, while Christmas will happen, the country's tenanted pubs will then have January and February to look forward to.

There are also those previously-mentioned VAT quarters that often fall on the traditional quarter days (end-March, June, September and December). And the same, of course, applies to rent payments.

The health of a pubco is closely linked to that of its tenants and lessees. We believe they are struggling, that they will continue to do so and that this cannot be good news for the ultimate owners of their outlets. What does this mean?

Well, if an average tenant is facing a £30,000 drop in income and has no financial fat to fall back on, then he must either: 1) receive substantial financial support; or 2) fall over.

There seem to be few possible alternatives and, if we are too pessimistic in our analysis (and only half of tenants face a drop in income of half the amount that we suggest), then owners of 7,500 pubs may have to transfer, one way or another, £50m to £60m per annum to their tenants in order to support them. This may need to persist for one, two or perhaps three years.

If we are not being too pessimistic, then the transfer may need to be up to four times as large and that has implications for the pubcos' dividends, cash-flows and other use of funds.

Trading figures: Current year / year one​

Sales income: £360,000 / £289,357

Gross profit: £159,824 / £143,690

Gross margin: 52.2% / 49.6%

Costs: £123,824 / £136,831

Trading profit: £36,000 / £6,859

Interest: £3,150 / £3,600

Net profit: £32,850 / £3,259 ​

This is an edited version of Mark Brumby's seven-page analysis.​