Bear necessity tests tenancies

Last November at results time, Enterprise Inns executives were on the receiving end of quite a few questions from City analysts about its resilience in the face of an economic downturn.

How were tenanted pubs affected back in the early 1990s when the vast majority were under the ownership of old-style brewers?

Chairman Hubert Reid said he thought tenanted pubs tended to be very resilient in a downturn. Furthermore, today's average Enterprise pub, with combined average Enterprise and licensee profit of £115,000 per annum (pubco: £68,000, licensee: £47,000 including £10,000 live-in benefit), was a managed house then.

What would it take, though, for Enterprise to actually feel the pain of a downturn? The answer: a 15% drop in the carrying value of its property estate. If this occurred, the company would, analysts were told, "bump into a covenant". Finance director David George pointed out that it would take a 15% drop in the company's Ebitda. Not very likely, it was stressed.

Almost a year on and Enterprise, Punch Taverns and fellow tenanted operators are subject to the most bearish sentiment in living memory. A fair number of tenants are in receipt of financial support as they struggle in the current climate and some analysts are advising investors to avoid pubco stocks for the time being.

Last month, Morgan Stanley analyst Jamie Rollo set out the main planks of the bear case. It's worth examining them and looking at what the average tenanted pub company can do to address whatever problems are arising. Firstly, is there any evidence of more pubs on the letting list as licensees leave the sector because they can't make a living?

As yet, there's no evidence of a frenzy of abandonment in either estate.

On Tuesday, Enterprise Inns reported that the figure for pubs to let was actually down compared to six months ago and stood at less than 10% of the estate. Punch Taverns chief executive Giles Thorley insists there has been "no recent deterioration in the number of pubs available" and dismissed fears there are problems finding new tenants. "There are plenty of people looking to get into pubs," he said. "We leased more than 800 pubs in the year to August and we did 100 in August alone."

One reason why there's been no dramatic upward spike in departures is the degree of support Punch and Enterprise has opted to provide. More than 1,000 pubs in each estate have effectively been in intensive care. Rent concessions and improved beer discounts amount to re-apportionment of the profit pie in favour of tenants.

Enterprise divisional director for the Home Counties Nick Light provided a recent BII rent review seminar at Chepstow with an insight into how "hands-on" support is when provided. Enterprise had 850 licensees receiving support at its last results. A full wet tie is imposed for the three months of support with discounts of £100 a barrel available.

Clear understanding​

Enterprise obtains, in Light's words, a "clear understanding of the sales performance" of each pub. In other words, Enterprise will be getting a crystal clear picture of current trading trends in its troubled bottom-tier pubs — and will be well-positioned to react accordingly.

What was surprising is that at the last results, the cost of this worked out at an average of £300 per pub for the first half year — Enterprise's average earnings per pub, as yet, have suffered the tiniest of dents. Likewise, Punch's rent concessions amount to just 3% of the rent roll.

Let's not forget both Punch and Enterprise have a large and healthy top end where normal earnings increases provide a hedge against the poor performers.

Share prices at the moment factor in all sorts of bits of concern and caution: the current Bec review stripping pubcos of machine income; fears that the beer tie will eventually turn tenanted pubs more and more uncompetitive; debt structures, particularly in Punch's case, trapping cash to the detriment of shareholders; pub companies eventually seeing reduced rental earning if rent review outcomes reflect declining beer incomes.

For the moment, there is one undeniable certainty: the oft-repeated claim about the resilience of the tenanted pubco model is getting the biggest test since the model's creation.