Douglas Jack at Numis Securities has issued a Travel and Leisure Industry Update in which he argues that there is a tougher trading environment for pubs than restaurants, which are now outperforming managed pubs. The Update summary provides a useful overview of current and prospective market conditions:
“The August Peach Tracker, which excluded the washout bank holiday weekend, and our c.3% forecast downgrades for Greene King and Marston’s reflect a tougher trading backdrop for pubs, in addition to which weather-related comps will be relatively tough for pubs over the next 11 months. We believe this and an arguably over-heated property market will heighten the importance of product differentiation and capital discipline.
- The economic backdrop has improved due to: benign cost pressure, a 2.6% increase in employment and 2.1% growth in household cash flow. This is driving up consumer confidence, but this is less influential on short-term managed pub performance than the weather. Over the next year, good weather comps will be tough for pubs and easy for Domino’s Pizza (Buy 710p) and The Restaurant Group (Add 760p), which should also benefit from strong cinema releases and a World Cup in the comps.
- Restaurants (2.6% LFL sales MAT) are now outperforming managed pubs (2.0% LFL sales MAT) in the CGA Peach Tracker. The eating out market has become more event-driven; pubs will need to be wary of trading up if the economy continues to strengthen. Regardless, eating out should outperform drinking out; thus, we continue to prefer managed pubs (mostly food-led) to tenanted pubs (mostly wet-led).
- Wet-led pubs’ beer/cider volumes fell 6.4% MAT in Q2 2014, improving from a previous run rate of -8% due to good weather and the World Cup. We expect long-run trends to resume: the difference between on and off trade beer prices has risen by 10.7% over the last two years, even though beer duty fell. Thus, drinking out is falling by 1% pa in value terms vs. eating out growing at over 5% pa.
- There is no positive read-through to the other national pub operators, particularly with Greene King’s Hungry Horse currently offering 30% discounts (through Voucher Codes) on already good-value meals. For 2015E, we forecast 2% LFL sales growth for both Mitchells & Butlers (Hold 420p) and Spirit Pub Company (Buy 110p), which we believe the latter (the most undervalued pub company) is more likely to achieve.
Growth is becoming more reliant on increasing scale than driving LFL profits. With expansive operators bidding up freehold prices, the value of strong established site pipelines has increased, both in terms of managing returns and growth visibility. Hence, our preferred stocks are: Domino’s Pizza (growth; returning cash); Marston’s (dividend yield); The Restaurant Group (growth); and Spirit Pub Company (growth; valuation).”