Punch - Bottom Of The Glass
All,
Please find our updated analysis of Punch Pubs here.
Q3 has been somewhat uneventful, most notably solidifying management’s departure from the previous conversion strategy that foresaw selling pubs to fund the conversion of some of them from L&T into MPs. The company only converted one such pub, while CapEx is now focussed on the wet estate where beer inflation is running at 12% p.a. With pub economics being what they are, that currently allows for cost rises of up to 17% to be offset before volumes start dropping off. June and July have kept up those inflation rates, making us increasingly comfortable that Punch have seen the bottom of the glass and are on the way to recovery. Now it’s just a matter of timing.
Investment Rationale:
- We are gradually warming up to this name. So far the group is weathering the Cost of Living storm relatively well. Major cost items and headwinds are being passed through and beer inflation at 12% helps defend market share on those higher prices. Price elasticity of demand is such that brewers can raise prices up to the expense of volumes to recover cost increases and at the moment all of them are in that game. We think the estate is more likely than not to refinance in 2026, but on the flipside, it won't withstand another downturn of sorts.
- LTM FCF after lease expenses and before divestitures is still negative. But beer inflation should allow this metric to turn around. The questions are how fast and how far. We are not modelling a complete return to margins by 2025, but it could be borderline sufficient to refinance the bonds. If not, we think only a little contribution would likely do the job for Fortress and otherwise there is a good chance the group outperforms our expectation and that in the next years the market becomes easier too (betting on the latter is admittedly not a great investment strategy).
Q323 Update:
- The Group disposed of 11 pubs in the quarter generating proceeds of £6.4m, at £0.7m above book value. We no longer actually take this to mean that only 11 pubs were sellable at BV. Rather that is the rate at which the company needs to sell assets to fund its plans and apparently those can be met at BV. That's a good signal.
- The conversion of only one pub to MP confirms the previously flagged pivot in strategy towards investing into the wet let estate.
- YoY growth in Q3 has slowed down vs the previous quarter, perhaps as a result of the heavy beer inflation of 12% p.a. that has taken hold across the nation. Or perhaps Q323 lacked a coronation or other major event.
- At 12% beer inflation, volumes sold seem to have been constant across the estate.
Working Capital:
- We are anticipating WC flows to remain flat going forward, although swings can be over £10m in any quarter. There is an argument for inflows as NWC is negative and because going forward there will be less conversion of pubs to the managed estate, which used to bring on balance sheet more inventory for longer.
CapEx:
- The new strategy involves mere investment in the wet-let estate, which has an easier time passing on the beer inflation (variable cost) and where the publicans are sitting on the fixed cost increase.
- Note that we are not hearing of mass insolvencies among publicans however.
Other Investing:
- Note that Punch does not generate sufficient CF to fund pub conversion in the first place. CapEx as a result of the increased rate of conversion was expected to be £30-35m p.a. (probably at the higher range). To fund it, management expected selling down the estate at approx. £10-15m p.a.
- Nonetheless, divestitures picked up markedly in Q223, suggesting that the overall investment in the estate (from these cashflows) will remain approx. the same.
Here to discuss,
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk