Packing A Punch

Many believe Punch Taverns' size and dominance of the leased pub sector effectively renders the group the industry's 'belweather'.

Such people would have smiled wryly as chief executive Giles Thorley outlined the pubco's trading prospects to journalists at the end of last month, only to be interrupted by a tremendous clap of thunder above the building. It then began to rain. Heavily.

Pub industry doom merchants would surely have read portentous signs into such a meteorological event, but Thorley was unfazed.

Smaller leaner estate?

Having reduced the size of his pub estate since the group reported first half figures a year ago, Thorley believes Punch is in possession of a leaner, effectively more profitable pub estate - both managed sites and leased - as the industry heads into a tough few months.

Against an all-too-familiar trading background Thorley admits he is "not desperately confident" going into the second half of the year, but he hopes both his business and the industry in general will see a reasonable change in fortunes as the summer months come into play - and definitely within 12 months as the smoking ban "starts to unwind".

"Yes, we're very cautious about short-term trading," he says. "But in two to five years time? The pub will still have a place in UK culture and we own the best ones. Yes, some pubs will close. Hopefully, they won't be ours."

Is such optimism justified? The reduced size of the Punch estate and its focus on more qualitative pubs is a key factor in the recent trading performance, Thorley claims. He points to average revenue growth performance per leased pub which shows beer up four per cent; machine income up two per cent, other drinks up 12 per cent, while rents rose 16 per cent. A leased estate shorn of more than 500 pubs has certainly helped such numbers.

Across its managed estate, Punch reported drink sales up four per cent but food sales up more than a third. Indeed food sales now account for 39 per cent of all turnover in Punch's managed estate, itself a third smaller than a year ago, thanks to leased conversions and some disposals.

Punch has a better quality 'tail' than ever before, where the smaller pubs are bigger than they were, notes Thorley. "We won't sell off any more chunks of the tail unless we've got better things to replace it with. Our infrastructure would become too expensive if we got much smaller," he says.

Though not the panacea to the industry's ills, the provision of a "credible food offer" is set to become an important part of the Punch model, Thorley says. As is the provision of more letting rooms through the group's Good Night Inn brand, a concept split into 'Lodge' and 'Heritage' operations, which he believes works well next to existing pubs, where feasible. Plans are afoot to add 1,000 more rooms to the current portfolio. "Not massive," admits Thorley, but another opportunity all the same.

Meanwhile, declining beer volumes, that hot topic for many observers, "aren't everything" he says, especially when one looks at popular new products such as Beck's Vier, which can attract a premium price tag.

At around 300 pubs closed, the number of shuttered Punch sites was marginally higher than the same time last year, while the value of rent concessions rose to around £4.2m - a figure not deemed particularly significant by analysts. City types were quite taken with a six per cent average uplift on rent review and a 14 per cent average uplift on lease renewal.

Bullish about the balance sheet

The group's balance sheet remains strong, with no refinancing necessary until December 2010, while interest cover on existing debt edged upwards from 1.9 times to a shade more than two times.

Indeed most - though by no means all - in the Square Mile remain reasonably bullish about Punch, despite the group's shares falling to 545p since their year-high of 1,401p 11 months ago. After all, most stocks have headed south, but Punch is deemed relatively cheap compared with a number of its peers.

What the City does fear - based on the evidence of other more property-focused pub operators - is a trading downturn leading to large numbers of licensees throwing in the towel. Empty pubs are bad for business and one's share price, after all.

Punch doesn't want pubs to be handed back, says Thorley, "but people have to help themselves to some extent." He is keen to emphasise the lengths his company goes to in order to support the group's 'customers', aka lessees.

"On something like rent we'll look at why the trading is down. It might be the smoking ban, but it might be the attitude of the guy behind the bar." There are those who accuse Punch of placing temporary managers into troubled pubs in order to trade through a key reporting period - "resetting the clock" as one observer put it - although this is a claim Punch vigorously denies.

Still, Thorley admits his company has to work harder to get the message across that it understands the pressures on lessees in today's market.

"Our reputation was appalling and we've fundamentally changed that," he says, pointing to a variety of support initiatives for new and existing licensees. "But we can always do better. Yes, there are people who hate us, but there are people who hate Tesco and in my view (chief executive) Terry Leahy is one of the greatest businessmen of our time."

Thorley concedes it is not the best time to be in the pub trade, but he believes recovery will come. "We accept there is weakness in the short term," he says. "But we're not seeing a massive uplift in bad debts and we're dealing with the issues. Overall we think the prognosis is good."

Thorley on Mitchells & Butlers and the deal that never was"We have a responsibility to our shareholders to consider proposals for our businesses.

"In this case we didn't receive a proposal, we received an approach. Our chairman met their chairman recently to talk about 'stuff'. We are not net sellers, and now is not the time to maximise value [via a sale of Spirit Group]. The market is at a low point right now and yet Spirit is in a stronger position after two years of our owning it. We are net buyers and we look for opportunities. Our proposal to merge with M&B was one such opportunity.

"In the end we walked away because the situation was not suitable. It wasn't anything to do with the personalities involved, it was to do with the financial markets. We didn't need M&B; you only have to look at our results to see that. Would we change our view [on a deal] if there were to be a change in the senior management at M&B? It is unlikely. I haven't spoken to [M&B chief executive] Tim Clarke since the second week in March."

What the City said

"We are cutting our 2008 pre-tax profit forecast by two per cent to £275m (EPS from 81.4p to 79.4p), despite easier like-for-like comparatives, the passing of the English smoking ban anniversary and another £10m annualised central cost savings throughout the second half." - Douglas Jack, Panmure Gordon​

"Weaker recent trading leads us to cut our like-for-like assumptions from down one per cent to down three per cent. Although we see long-term value in Punch Taverns we suspect the shares are likely to languish until there is hard evidence of a recovery in trading. Even then we suspect any rebound will be modest." - James Ainley, JP Morgan​

"It is encouraging that Punch has reported a 10 per cent increase in EBITDA per pub in the leased estate and that average licensee profitability rose 11 per cent to £40k. The group's tenanted model remains robust and firmly intact, in our view." - Richard Carter, Numis​

"Despite the tough market the leased division was ahead of our forecasts, despite fewer pubs trading than expected. On the managed side, higher labour and depreciation costs impacted operating margins by around 200 basis points more than we had expected. It was d