I’ll not deconstruct my idea behind this purchase too much except to say that at 100p Punch Taverns represents safety because:
- I am investing with money I can afford to lose which means I am willing to watch it go to 5p and it simply would not bother me
- Punch’s share price is at an all-time low; a good thing but it could easily go lower (see chart below)
- A switch from negative to positive earnings as a result of disposals (not a long term source of cash)
- Based on these earnings a PE Ratio of 4.32
- CEO appointed last June (2015) has a credible plan to change the fortunes of Punch which has already begun to bear fruit
- The balance sheet was made more transparent by the time prelims were announced on 12 November 2015
Here’s what Duncan Garrood, Chief Executive Officer had to say back in November:
The conclusions announced today represent an evolution of our existing plan. It is also designed to address the many structural and regulatory changes impacting our market.
Our strategy enables us to maximise the value in our properties through a phased, lower risk approach to addressing an evolving pub market, taking greater control of the property and retail offer, but without the added overhead that comes with directly employing pub staff.
We have already made significant steps towards evolving our operating model and financial position, and while we have a lot to do, we are well placed to deliver on our plan
Punch Taverns Long-Term Chart
Courtesy of Yahoo! Finance
The balance sheet was made cleaner by selling 158 pubs and a 50% stake in a JV for a total of £153 million.
Net debt was reduced by over £500 million.
Long term debt is secured against Punch’s property portfolio which was independently revalued to and increased by £9 million.
All of this makes sense and is a smart way of arranging the finances but management will need to keep an eye on the pension deficit which is increasing.
They will also need to keep and eye on the high levels of debt still showing on the balance sheet even after a bit of a tidy up: debt to equity excluding intangibles is a massive 3.
A dozen long term loan notes with interest rates of over 7% and maturing between 2021/28 are responsible: they total £1,600 million which is high given that the value of the property portfolio is only £2,097 million
Of greater concern are the legislative changes that will significantly impact Punch’s operating model whereby publicans who rent premises from Punch and share in the profits of drinks sales will have the right to opt out of the supply of drinks and simply pay rent to Punch for each premesis.
This so called MRO is a proposed Statutory Code, independent adjudicator and a Market Rent Only option (“MRO”) for all companies with over 500 pubs:
In our 2017 financial year we expect up to 400 potential MRO event triggers in the core estate and up to 300 event triggers per year in the following four years. In the event that a lessee elected to invoke the MRO option, whilst our income derived from the supply of tied drinks products would be partially offset by increases in rent, we are aware of the potential for our total income to be adversely affected.
For the 2015 financial year Punch generated GBP248 million of net income of which GBP134 million was from the sale of drinks, GBP102m from rental income and GBP12 million of machine and other income. Of the GBP134 million of drinks income, approximately GBP72 million was from core pubs with a potential at some time in the future for an MRO event trigger to occur.
Room for growth
Despite the uncertainties of the future Garood recognises that Punch owns a large amount of land some of which is underutilized.
Other growth opportunities include meeting the demands of consumer trends which Punch have done in a number of their pubs already with success and since operating profit is only as high as it is because of disposals sooner or later Punch will run out of assets to sell and will simply need to focus on selling more drinks.
The challenges facing Punch are enormous but not insurmountable in my view and at 100p I’m happy to hold for the very long term and evaluate how management will cope with these challenges.