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Wed 21st Nov 2012 - Propel Opinion Special

Morning Briefing opinion special: The key challenges at Enterprise Inns by Ted Tuppen


We put our challenges into three categories - trading, debt and property.

As far as trading goes, we have invested in our estate and we’ve positioned ourselves now for real like-for-like growth. We are getting improvement across all geographies with the south, which represents 42 per cent of our income, firmly in growth. We targeted flat like-for likes in the second half of our financial year and missed it by a couple of million pounds, despite a poor summer and the negative impact of the Olympics. Two million pounds is about 12,000 barrels of beer and with sales close to mid-January levels during the two weeks of the Olympics, the £2 million of income were lost in those two weeks alone. So we think that the 1.2 per cent like-for-like downward shift across the estate for the year is very acceptable in the circumstances that we were facing. 

We made real progress on the debt front – a £266 million overall reduction, with Tranche B repaid, floating rate notes all repaid, fixed rate notes purchased in advance and the banks financing completed with a flight-path to zero bank debt or thereabouts. We have restored confidence in the debt markets with our bonds trading up by an average of 21 per cent. Okay, we’ve lost some of the discount arbitrage. But I would rather recognise the refinancing confidence that we get from seeing the 2018 notes trading close to par value with a yield of around 7.2 per cent. 

On the property front we have reorganised our property function to enhance our investment efficiency and recognise that £4.3 billion of freehold assets should be a profit opportunity. We have delivered a £208 million disposal programme, 102 exceptional trading pubs have been sold at 14 times income, probably about 16 times EBITDA and a 28 per cent profit over book value. 199 non-viable pubs have been sold at an average of £336,000 compared to £227,000 last year. Our annual re-valution has addressed the tail but of course takes no account of the upside opportunities.

Where to next in 2013 and beyond? In many ways it’s the same story moving on to the next stage. The same headings are relevant - trading, debt and property – and, not before time, shareholders.

In respect of trading, the business model works. We provide the platform and the support for great entrepreneurs to run their own pubs. Like-for-like value of our beer sales is up nearly seven per cent during the year - the sort of like-for-like sales increases that managed house operators would find very acceptable. We have invested in our people, we know where to invest – improving kerb appeal and providing great ranges of beers, food, plus entertainment, technology and accommodation. We have to buy smarter, we have to sell more, but we are well placed to do that.

On the debt front, we have solved the major issues and now we have some choices. Our debt is secure, manageable, tax efficient and predominantly at fixed interest rates. It’s worth noting that £35 million of debt repurchased at a ten per cent discount creates equivalent value to a one per cent growth in like-for-like EBITDA. Debt is no longer just a risk, it represents an opportunity for us to create value for shareholders.

On the property front, and I say this with no particular pleasure, we have about 700 pubs where we rate the external condition as not good enough - poor. In 12 months, we won’t have any pubs in that condition, we won’t have any poor condition pubs. Discipline, enforcement, investment and disposal are the key. And we will continue with our disposal programme, improving the quality of the estate by tail-end disposals and maximising the value of every sale whether it’s through high prices for exceptional trading assets or alternative use where applicable. 

In respect of shareholders, this has been quite a journey back from the dark days of 2008 when dividends ceased and the share price collapsed by 95 per cent. On the positive side, net asset value has been kept intact during the past four years, somewhere just shy of £3-a-share although Earnings Per Share (EPS) has pretty much halved. Now is the time to deliver like-for-like income growth and EPS growth and to rebuild confidence in our business model and our asset value.

In terms of delivering shareholder value, I just want to deal with a couple of fairly obvious points. Firstly, our net asset value is £1.4 billion or around £2.85 per share. We trade at 65p, a discount 75 per cent to net asset value. On a total assets basis, the market appears to believe that our pub estate is overvalued by about 27 per cent. Clearly, there is something for us to address there.

Secondly, looking at our cash generation chart, excluding disposals and capex, which, in steady state, would pretty much offset each other, we generated net cash of around £100 million last year. On an entirely hypothetical basis, let’s now look at value creation over the next three years. Let’s ignore disposals or assume that they will generate cash proceeds broadly in line with net book value. Let’s ignore dividends. If we pay dividends, the money goes to shareholders anyway. Let’s ignore the relatively immaterial cash impact of like-for-like growth and decline or the purchase of debt at a discount. (This is not a forecast or a financial model, it’s a theoretical representation of the future.) If we use our £100 million of cash generation to pay down debt, all things being equal, and our enterprise value remains the same, the mathematics demonstrates that the value of our equity will double over the next three years, an Internal Rate of Return of just under 30 per cent. If confidence in our balance sheet improves, if debt ratios are deemed to be less of a risk, if we can deliver growth in EBITDA or earnings per share, then a re-rating might help to push the total enterprise value towards our true balance sheet value. For management and for shareholders, this is certainly a prize worth working for.

As far as the outlook goes, we have a great pub estate and some great publicans - and through investment, training and support they are getting better all the time. We have strengthened the team significantly and I have great confidence that we can perform well whatever the market throws at us. But let us be clear, the market isn’t great and it’s not suddenly going to become great. We are looking for like-for-like net income stability in 2013 but the First Quarter of this financial year will be difficult as our like-for-like sales will take the hit of losing £1-2 million on the WaverleyTBS collapse and we face very strong comparables from last October, in particular, when the weather was glorious. First quarter like-for-likes probably won’t look that good but for the full year we believe we won’t be far off achieving flat like-for-likes, plus or minus a bit. 

In the face of rising costs for our publicans, the last five years have seen us reduce like-for-like rents by 12 per cent and increase discounts on beer by £28 per barrel. I just want to dwell for a moment on that transfer of value, which together has cost us in the region of £54 million this year alone – an equivalent value transfer from us to our publicans of £9,000 per pub per year. It is ironic that some politicians chose to attack our business model when we have transferred an average of £9,000 profit per pub towards helping our publicans remain profitable in a time of rising costs, seeing our like-for-like income fall from £74,000 to £65,000 per pub. Over the same period, the Treasury have orchestrated an increase in their tax take from £120,000 to an astonishing £145,000 per pub. Between them our pub estate contributes almost £900 million to the Treasury.

Despite these challenging economics, our business remains robust, the vast majority of publicans are working with us for mutual success and most under-performers have left the business. We are close to stability in like-for-like income per pub, our balance sheet is fairly valued and strong, our debts are manageable, our cash generation is strong and we believe that we can generate real value for our shareholders.
Ted Tuppen is chief executive of Enterprise Inns

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