The company, which according to research by Deutsche Bank pays 60% of its workers aged over 25 the minimum wage, has seen its share price dip 18%.
Numis analyst Douglas Jack moved his recommendation to Add from Hold. The company’s Q3 statement is due on Wednesday, 29 July.
He said: “Following c.13% downgrades to our 2017E PBT forecasts to reflect the National Living Wage, there should be limited downside to forecasts, but medium-term upside if the company’s operational efforts gain traction.
He said: “LFL sales rose 1.4% (food 2.5%; drink 0.3%) over the first 32 weeks. We forecast them to remain around this level, supported by easing comps (H1 1.1%; H2 0.0%), efforts to improve service standards (net promoter scores are up and staff turnover is down), as well as increased levels of capex on maintenance (up to £70m from £58m in H1), and improved IT systems.
“H1’s 67bps decline in EBIT margins was due to initial dilution from the Orchid acquisition and food growth being driven by volume. Our forecast of 20bps margin growth in H2 reflects easier LFL sales comps and easing cost pressure.
“Nine new outlets opened in H1 (vs. a FY target of 25), in addition to 23 conversions (of which 14 were Orchid sites). Despite rising capex and relatively low returns on capex (15% on freehold acquisitions; 18% on leasehold acquisitions; and 23% on conversions), net debt/EBITDA fell to 4.4x from 4.6x in H1.
“Share price weakness reflects forecasts readjusting down for National Living Wage. Guidance was for over £30m off PBT in 2017E, yet consensus has so far only fallen by £7m (3%) to £231m. We believe the company’s guidance reflects a 5% increase in ALL outlet-level labour costs, with no offsetting benefit from labour scheduling and increasing consumer cash flow.
“M&B has a high quality managed estate, which is currently valued on a P/E of 11x and an EV/EBITDA of 9.2x. The EV/EBITDA would be 7.8x if the pension deficit (equivalent to £1.20/share) did not exist, a scenario that could emerge if interest rates rise. We believe there should now be limited downside risk to forecasts and valuation, but it is likely that investors will have to continue to be patient if they are waiting for a positive catalyst (such as a resumption in dividends).”