Morgan Stanley are calling an official end to the good times this morning — in a note entitled “repent at leisure”.
We now incorporate a deep multi-year recession in our forecasts, and no longer assume a sharp 2010 recovery. We had already cut EPS significantly for many stocks and this report brings others into line, with average cuts of 25%. Our new forecasts match the bear case in our last sector report.
Of particular note, the outlook for Punch taverns — frankenfinance pubco par excellence:
Forecasts and valuation. We are downgrading our rating to Underweight from Equal-weight to formalize our already cautious stance. We downgraded our EPS forecasts by 12% a few weeks ago, to assume -5% L4L in 2009e, and on this basis the shares look cheap (1.6x P/E). However, this disguises the fact that on our forecasts the company will have its cash trapped in all three securitization structures by 2011, and will also be close to its covenants (particularly Punch B and Spirit).
(Covenants which if tripped would sever Punch’s assets from the company.)
Although we think Punch has effected enough changes to redeem its convertible with internal cash generation, there are not that many balance sheet options open to it, and as debt service rises, and EBITDA declines, risks are rising. In addition, we think the tenanted/leased business model is coming under increasing pressure as many leases appear overrented, the beer tie means beer is relatively expensive in an era of growing pricing discounting, and many pubs are underinvested. If Punch manages not to breach covenants, we assume the shares should be trading on a P/E of 6x (i.e. 25% discount to the UK market). So the current P/E of 1.6x implies a 25% chance of no breach, which sounds low. Despite this, and despite the upside to our new 195p price target, we struggle to recommend Punch given its stretched balance sheet and think for many it is uninvestable. Our bear case is based on a 15% profit decline which would lead Punch to breach covenants in Punch B and Spirit in Q1 11 and Q3 09 respectively. This would trigger major restructuring such as a debt for equity swap and would leave minimal value in the equity, which we have estimated at 10p.
Current price of Punch: 114p (down 8.76 per cent today)