Interactive Investor

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Analyst Edmond Jackson asks whether a 70% discount to net assets is over-compensating for the risks here.

24th October 2023 12:00

Edmond Jackson from interactive investor

There has been notable strength in pub stocks after the Rugby World Cup helped drive a 6% rise in spending at pubs and bars during September – fine weather also helping.  

Moreover and as a bellwether, Wetherspoon (J D) (LSE:JDW) turned profitable in its year to 30 July saying it currently anticipates “a reasonable outcome for the (new) financial year, subject to our future sales performance”. This helped stocks rise given they were priced for worse. 

In which context it is interesting how around 28p, small-cap Marston's (LSE:MARS) languishes at a long-term low versus an 11 October pre-close update for its financial year to 30 September declaring: “12% like-for-like performance most recently” as the benefits of a turnaround strategy manifest. 

A classic asset-rich, cash-poor situation 

Over £1 billion debt has depressed Marston’s equity market value to around £185 million but disposals are gradually reducing the load. A key question is whether those “non-core” can suffice, or genuinely cutting Marston’s debt would eat into core assets, hence earning power.  

At least it appears covenants are not onerous, such that shareholders could get wiped out if trading turns tough. 

The group’s circa 1,440 pub portfolio favours sub-urban locations. Recalling initial years after the 2008 financial crisis: despite lower consumer spending, Britons kept eating and drinking out such that respected service outlets benefited. Amid current labour shortages, people in good jobs are currently enjoy inflation-linked wages. So, despite higher food and drink prices, selective hospitality stocks may prosper – if bought at a decent price. 

Marston’s annual sales are over £800 million, which, if consensus is fair, will get substantially towards £900 million in the current year to September 2024. 

£1,096 million debt is chiefly long term but only £19 million cash on last April’s balance sheet means net gearing of 257% - with a blessing of sorts, 93% of such debt is hedged hence without risk of interest rate changes.  

This limited the interest rate rise to 8% during the first-half year to 31 March although its £49 million net cost more than wiped out £45 million operating profit. There have been no dividends since 2019. 

Consensus expects net profit to fall from £137 million in 2022 to £35 million this year then near £47 million in 2024 – implying earnings per share (EPS) around 7p, hence a price/earnings (PE) multiple of just four times. 

Marston's - financial summary
Year-end 1 Oct

 201720182019202020212022
Turnover (£ million)9921,140784516402800
Operating margin (%)17.011.710.3-55.7-26.618.2
Operating profit (£m)16813380.3-287-107146
Net profit (£m)84.745.0-17.7-360163137
EPS - reported (p)14.17.0-5.9-55.1-20.321.4
EPS - normalised (p)16.715.36.03.3-0.413.1
Operating cashflow/share (p)35.528.530.924.75.520.9
Capital expenditure/share (p)32.625.421.210.17.410.9
Free cashflow/share (p)2.93.19.814.7-1.910.0
Dividends per share (p)7.57.57.50.00.00.0
Covered by earnings (x)1.90.9-0.80.00.00.0
Return on total capital (%)6.65.23.3-13.0-4.96.5
Cash (£m)17516139.636.629.825.1
Net debt (£m)1,3291,3861,3991,6391,6101,600
Net assets (£m)931919774249406648
Net assets per share (p)14714512239.364.1102

Source: company accounts.

Risk of debt covenant breaches is allegedly mitigated 

Last May’s interims cited “a successful amendment and extension to our banking facility and private placement to the end of January 2025...we secured covenant amendments...therefore a range of medium and long-term financing...an appropriate level and flexibility and liquidity for the medium term”. 

If this is fair to assume, and the UK does not experience a steep recession, the stock is over-discounting risks. 

Since market expectations began shifting towards higher interest rates from late summer 2021, it has declined persistently from near 100p. It actually trades at a 20-year low from 330p in early 2007, including a slump to 70p in late 2008 then volatile-sideways trading up to Covid lockdowns in 2020. 

A 70% discount to net assets therefore looks excessive. April’s balance sheet had only £35 million intangible assets versus £2,119 million property/plant/equipment, with net tangible assets of £585 million equivalent to 92p a share. 

Yes, property-related companies do often trade at a discount to net assets, especially in tough times. But that might be more like a 20% to 30% range than 70%. Moreover and in stark contrast, Wetherspoon trades at over twice net assets. 

Is a medium-term goal to reduce debt below £1 billion enough? 

Narrowing this discount, hence also establishing a relatively more normal PE, depends on management steadily grinding down the debt – also a resilient-to-improving narrative on trading. 

The 11 October update cited £55 million non-core pub sale proceeds (net of VAT) with the expectation of around £50 million additional such in the current financial year. 

Mind, the interim cash flow statement included £41 million for “purchase of property, plant and equipment and intangible assets”, which begs the question, is there not an opportunity cost – of compromising investment – if Marston’s is to remain competitive? 

While disposals have been cited at a 39% premium to net book value, the dilemma remains how to genuinely cut debt without shedding the core estate? 

Additional to £55 million generated by non-core disposals in the latest financial year, “we have concluded a further strategic assessment of assets and in the 2024 year expect to dispose of around £50 million additional non-core properties”. Is the definition of “non-core” shifting as debt reduction becomes a priority? 

Another option perhaps, could be selling the Carlsberg Marston’s Brewing Company, but again this does not seem able to transform gearing – having contributed a modest £2 million income in the first-half year versus a £2 million like-for-like loss. How strategically vital might this ownership be? 

The update re-iterates “a medium-term strategic goal of reducing borrowings below billion” yet Marston’s would remain highly geared. 

You could say, however, simply that a modest reduction in debt implies equity upside when the discount to net assets is circa 70%. 

At least the operations narrative is improving 

Within total annual retail sales up 11.3% on last year, like-for-like sales rise 10.1% reflecting “strong drink and food sales also resilience and appeal of our predominantly suburban pub estate”. 

This incorporates a relatively lower 7.7% advance in the final 10 weeks, blamed on wet weather rather than discretionary spending. 

“Our strategy remains centred on delivering affordable pub experiences for our guests in a quality environment, both inside and out. The level of customer demand remains encouraging, and we have continued to make positive progress on guest satisfaction measures.” 

A franchise model has been trialled in 19 food-led pubs to complement 714 wet-led pubs operated in this way. Sales growth significantly beat the broader food business and 50 food-led franchised pubs are targeted this financial year. 

Energy costs have been fixed (quite whether at high prices) also a significant proportion of food and drink costs, “providing us with a high degree of confidence for the next financial year”. 

A £5 million reduction in head-office staff costs is expected to help profits going forward, constituting a 0.5% improvement in the operating margin where a further 1.5% advance is targeted over the next two to three years. The historic table shows strong double-digit operating margins pre-Covid. 

A speculation than pure gamble 

A measured view here is targeting possibly 50p a share given the asset base and likely resilient trading for suburban pubs. Wider risk appetite is likely to be significant and currently linked to whether the latest round of Arab/Israeli conflict remains localised to Gaza, or spreads. 

Marston’s offers a “margin of safety” aspect given its asset base, but the debt means its equity cannot rate investment grade. There are still intelligent reasons for experienced speculators to take interest. Buy. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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