There’s nothing like a (former) house broker scorned, as the Toxic Pub Company have found out on Thursday morning.
Jamie Rollo of ex-house broker Morgan Stanley reckons Punch Taverns might need to raise more equity if trading does not pick up and says the argument that selling pubs and buying back debt enhances net asset value is very weak to say the least.
Enjoy the note (we did):
We remain cautious on Punch and Enterprise.
Current trading is dire, look at the shocking chart below from the note. The company is not really helping us understand what is happening here, or what is causing the rent decline to accelerate in H2, but I think it may be due to lessees/tenants leaving and rent dropping in these pubs to attract new entrants. This does not show up in the closed pubs or lessee support KPIs, so it is a bit of a grey area. If we are correct, this could have a knock on impact on other lease reviews and renewals as pub rents are set in-line with similar pubs, meaning we could be in for several more years of decline.
We now forecast an 8% L4L drop in Leased this year, giving just 15p of EPS, a 30% downgrade. Every 1% on group L4Ls is now 1p to EPS, or 7%, gulp.
I think the argument that selling pubs and buying back debt enhances NAV and EPS is very weak to say the least, there are some mathematical examples in the attached report as to why the effect is marginal. I guess this is why the company appears to be backing away from this strategy.
Finally, remember the real issue which is the step-up in debt service costs over the next 5 years. The company has just updated its website for the DS figures post its debt repurchases (see first chart in the attached), and they rise from £340m to about £400m, versus the original peak debt service costs of £425m. Even if we take another £400m debt reduction to take this down 10% to £360m, our EBITDA estimate for 2011 is £417m, implying a total DSCR of 1.15x, below the average covenant (A and B 1.25x, Spirit 1.3x). This is pretty back of the envelope stuff, but I think broadly in the right ballpark. Selling pubs for 12x ebitda and buying back debt at close to par as they are doing does not really move the dial enough.
If L4Ls continue to deteriorate, Punch may therefore need more equity. Needless to say, these points apply to Enterprise as well, I think.
Ouch.
(The back story here, by the way, is that alongside results on Wednesday, Punch Taverns announced that Numis Securities had been appointed special broker’ alongside Bank of America Merrill Lynch and Goldman Sachs).
(However, it is also worth noting that Rollo was no fan of the Toxic Pub Company even when Morgan Stanley were broker. He already had an “underweight” on the company and was warning in July that Punch faced years of falling sales because of the structural challenges facing the industry).
Still, as a plugged in follower of Punch and Enterprise his opinions carry weight as we can see:
Oh, and here’s the shocking chart referred to above:
Related links:
Toxic pub valuations – FT Alphaville
Estate writedowns push Punch to £406m loss – FT
Punch Taverns – Lex