Punch and UK pub consolidation - should they sell?

Punch has already embarked on a path of pub disposals in order to pay down debt. It remains unclear how far this process could go.

 

When considering a disposal strategy, it will remain important to understand who the buyers for it's parcels might be.

 

Punch was created from a series of acquisitions which increased it's share of Pub ownership in the UK to nearly 20% at it's peak.

 

These acquisitions were indiscriminate in the sense that to acquire meaningful additional scale, whole entities such as Pubmaster or Spirit were purchased. Within these estates the quality of pub varied significantly, and Punch had a strategy to sell off the tail to the likes of Admiral Taverns whilst adding further quality at the top end of the estate. This strategy led to increased debt but also improved earnings over a number of years.

 

Faced with a collapse in it's share price, a reduction in the asset value of it's estate, and a downturn in the trading performance of its (wet led) pubs, Punch has been actively seeking buyers for it's estate over the past year. In considering whether this new strategy could be extended and accelerated to a declared aim of selling the entire estate, it is necessary to consider who might buy the pubs.

 

a) Managed House operators

There is a limited opportunity to sell some of the higher end (Spirit) pubs to JD Wetherspoon or Mitchells and Butlers. Both businesses would cherry pick and are unlikely to want to / be able to raise sufficient capital to make major inroads into the estate.

 

b) Regional Brewers

There have already been a number of small deals struck with then likes of Shepherd Neame, Adnams etc. These deals tend to be for c.10 pubs each and are limited to pubs that fit the target profile of the regional in question and a capital cost that the often conservative regionals feel comfortable with. Punch has probably done what it can with these potential buyers for the time being, and there is limited further scope.

 

c) Small multiple operators

There have also been a number of small disposals (3-5 pubs at a time) to some aspiring multiple operators. Access to capital will be a constraint here but it is to be expected that a number of further deals will be struck as the next 300-400 pubs are actively marketed. History suggests that there will be future consolidation amongst these smaller multiples and some will emerge as bigger players. This may be a couple of years off and could result in some players of sufficient size to be able to participate in a more meaningful break up of the Punch tenanted estate

 

d) Tenants and Independents

Despite a lot of interest from tenants, a relatively small number have been able to come up with the funds to acquire pubs from Punch at the required valuation. As the operating profits of individual units (particularly wet led) remain under pressure, this is unlikely to improve.

 

Also to be considered in this process is the impact on Punch supplier relationships as scale reduces. Business with most suppliers will already be c. 20% below velocities at their peak. Before the disposal strategy commenced, Punch were positioned as the largest UK pub company and were able to drive down terms with the major drinks suppliers accordingly. As purchase price reductions were not passed on to tenants, this resulted in improved profitability.

 

As quantities of pubs owned reduce, some of these supply agreements will come under pressure. There may be specific outlet distribution targets or minimum volume commitments in some contracts. Others may be for a specific term. There are downside risks to operating profit from any renegotiations (and no upsides left to take from the peak). By opting for a strategy of phased and gradual reduction in pub ownership, Punch is seeking to minimise these downside risks and retain operating margins.

 

Given the absence of immediately available buyers for the entire estate, and the risks to operating profit from a rapid and entire disposal programme, Punch is likely to maximise shareholder performance in the short term from the strategy it has adopted. This does not preclude a complete breakup in the future, and if market conditions pick up this option remains open with the most likely outcome a combination of Managed House operators taking the best of the estate and the emergence of some mid-range multiple operators.