Tim Martin: Face the brutal facts abouts pubs and tax

Stroll on, did the Deutsche folks spend the afternoon training for the Oktoberfest before they wrote this stuff?

Their views certainly don't seem to be borne out by the recent financial history of the three stocks they recommend buying, Greene King, Enterprise and M&B - helpfully illustrated in Figure 18 of their report. Enterprise's earnings per share or EPS (profits divided by the number of shares in existence) have declined by 53% since 2007 and M&B's have grown by only 2% in those seven years.

Google they're not, but if these are the top stocks, what does the rest of the industry look like?

Rose-tinted​

As regards Greene King, the Deutsche optimism is so pervasive that it has even rewritten history. Deutsche states that "...The Restaurant Group, Greene King and Wetherspoon are the only three major groups that are delivering above previous peak (2007)...EPS...". However, Greene King's accounts for 2007 unequivocally state that their EPS for that year were 65 pence, whereas Deutsche's own forecasts for 2014 estimate just under 62 pence, a 5% decline. Oops! An inconvenient fact is overridden by rose-tinted views.

The related inconvenient fact, since the Deutsche chaps are not, to say the least, our supporters, is that Wetherspoon is the runaway winner in the Deutsche Pub Stakes, having increased our EPS by a whacking 62% since 2007! And what do we say about this relentless Germanic optimism for the pub trade? It's rowlocks, actually. We say the overall pub industry is in a parlous and declining state, with a number of doughty exceptions fighting a rearguard action.

Enterprise, the biggest tenanted pubco, has seen its profits halve and the second biggest, Punch, is fighting to survive. The biggest managed company, M&B, has emerged from management turmoil, but Deutsche tell us that to "recover its lost position" it must resolve the "25% of its estate (which is) dragging down the rest of the group- and this is the most price sensitive section of the estate".

Turmoil​

Many smaller companies have bitten the dust, including substantial managed pubcos Barracuda, Regent Inns and Laurel, to name but a few. 10,000 pubs or so have shut down in the last decade, 15% of the total, and the government continues to review the tied house system, provoked by endless stories of licensee hardship.

The root cause of this turmoil, Wetherspoon and others believe, is tax. Pubs pay 20% VAT in respect of food sales and supermarkets pay nothing, allowing supermarkets to subsidise the price of their alcoholic drinks, never mind their food prices. In addition, pubs pay around 16 pence a pint in business rates, whereas supermarkets pay only about a tenth of this amount.

As the consequent price disparity between pubs and supermarkets has widened, unsustainable pressure has been imposed on the industry.

Indeed, as the Deutsche report itself states the "27% growth in take-home/off-trade sales (in the last 15 years) almost mirrors the decline in pub numbers...".  Tax differentials bite hardest in less well-off areas, hence M&B's problems in "price-sensitive" pubs and Deutsche's stated preference for investor exposure to the wealthier south-east.

Wetherspoon, the family brewers, Punch, Heineken and many others have joined Jacques Borel's VAT Club​ to campaign for tax equality with supermarkets. At the grassroots level and in boardrooms where directors understand pub economics, the industry is united in its support for this campaign.

Absent​

Market research, supported by common sense, suggests that almost 100% of Enterprise and Greene King tenants, for example, are in favour. Yet the three pubcos Deutsche recommends are conspicuously absent from the VAT Club and are silent as the grave on tax equality. Indeed, the tax issue does not rate a mention in the Deutsche tome.

Even the editor of the main pub newspaper, possibly due to the influence of the so-called "Directors' Club" he created, does not support the VAT Club. Why this gap between industry analysts, a few boardrooms and bigwigs, and the rest of us?

"Groupthink" is one part of the answer- the tendency of elites to believe that they and their peers know better is a well-known syndrome. Banks and regulators succumbed a few years back and Brussels' Eurocrats have alienated half Europe with their out-of-touch beliefs. Self-interest resulting from directors' bonus schemes is another toxic contributor.

Will it help those 3-year share options to say that the pub industry is under a severe commercial disadvantage with the still-mighty supermarkets? Or indeed, will it help Deutsche sell its Orchid pubs if it owns up to this sword of Damacles?

Just as you shouldn't bet against the Fed, you shouldn't back companies that suffer from a major tax disadvantage - especially if they appear not to realise it, or if they refuse to take up the cudgels for tax equality.

Now read PMA Group Editor Rob Willock's response