Sea change in the pub marketplace

We're in the midst of the third major stock market flip-flop of the past 15 years. The first major flip-flop occurred in the mid to late 1990s, in the wake of the Beer Orders.

Investor sentiment rushed behind the managed operators who were investing in the high street. The shares of quoted managed companies were trading, in some cases, at 25 times earnings at the high point of investor enthusiasm — nearly three times what might be regarded as a sensible multiple.

This irrational exuberance deflated as it became obvious that the strategy would result in over-investment and companies began to make excuses for their under-performance.

The second flip-flop came as investors took a shine to the large quoted tenanted companies. Year after year they grew their estates and profits ticked up.

The triple whammy of the recession, the smoking ban and a philosophical aversion to companies with large debts has produced the most recent flip-flop. (It could have been a lot worse for the quoted companies and their shareholders if the era of easy money hadn't allowed so many poor-quality banks to lend huge amounts to those with poor-quality plans to buy poor-quality pubs.)

The major managed companies and those with a substantial managed division component are back in (relative) favour.

The branded, managed food offer (Hungry Horse, Milestone, Harvester, Toby Carvery) is having a very good recession. One market analyst, Horizon, thinks the pub-restaurant sector (food sales 50% of all sales or more) has increased sales by 20% in the past two years. Meanwhile, the market is very wary of those with large amounts of debt and/or large tenanted estates.

The scale of marketplace change is something that would make anyone nervous. The six largest tenanted pubcos have shed or are in the process of shedding around 6,000 to 7,000 pubs.

At least one pubco chief executive reports that he is worried that shedding tenanted pubs might amount to many more years of amputation after amputation. The best share price performance in the tenanted sector is coming from those who can show they have a credible plan for their estates.

But there is a more fundamental issue here. The glacial melt of the large pubcos is a good thing for the wider prospects of the sector. Early evidence suggests that 60% to 70% of these pubs have a future in the independent sector, especially once they've had some investment.

The smoking ban has eroded the long-term profitability of many more tenanted pubs than had been hoped. The sector's quoted tenanted operators carry the impact of this in their share price.

Others in the independent sector can look forward to a steady stream of reasonably priced freeholds coming on to the market.