British pubs are struggling - here's a better bet on beer
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Associate Editor
David Stevenson Apr 30, 2009
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If ever you needed a classic example of the dangers of binge borrowing, it has to be Punch Taverns (LSE:PUB).
It's the UK's leading pub company with over 8,000 hostelries. Its balance sheet is full to the brim with borrowed money. Concerns over the scale of this debt pile are one big reason why the share price has fallen almost 90% over the past two years.
But yesterday, the company told us the debt pile's finally falling. So is this turnaround time – or have last orders merely been deferred…?
Why debt is such a problem in bear markets
What's the big difference between bull and bear markets? One of the first that springs to mind is investors' attitude to debt.
On the way up, few people seem to care how much debt businesses rack up. They reckon a company will be able to make a better return on the borrowed cash than the interest rate it's paying on the loan. But when share prices tumble, analysts suddenly start to fret about gearing again – i.e. a firm's loan level compared with its capital – and the ability of companies to service their debts.
My colleague Tim Bennett goes into detail in this week's magazine (if you're not already a subscriber, get your first three issues free here), so I'll not repeat that here. Except to say that some very scary cases of over-indebtedness have come under the spotlight.
Like Punch Taverns. Most of the company's pubs were bought on a borrowing binge. Punch's net asset value is £1.3bn, of which more than 40% is 'goodwill', i.e. an 'intangible' asset which generally arises from acquisitions, not a physical asset like cash or property. Yet Punch has an eye-watering £4.4bn of net debt. Ouch!
That's why Punch's market capitalisation has taken a pasting over the last two years, plunging almost 90% from its peak to just £400m as the market got the jitters the company wouldn't be able to pay its interest bill. The dividend getting the chop hasn't helped much, either.
Is Punch Taverns on the comeback trail?
But now, maybe there's a glimmer of hope. Punch has just told us it has managed to offload 162 pubs, cutting debt by 7% in the process. It's also trying to spice up 1,250 of its worst-performing outlets. The share price frothed up almost 40% yesterday and is nearly another 30% higher today. It's now more than four and a half times higher than its low point of three months ago.
On top of all the green shoots apparently appearing in the British economy, is Punch now on the comeback trail?
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Sadly for shareholders, probably not yet. As Capital Economics' Jonathan Loynes puts it, "the outlook for consumer spending [is] still very weak". With job losses soaring and house prices still falling, it's hard to argue with that. Looking forward, UK households are much more likely to cut their own bloated borrowings and save more, than splash cash around.
But even if Britain's consumers do dig yet another credit card out of their bottom drawers, it's unlikely to be pressed into service down the boozer. For one thing, people are eating out less these days – as Brewer's Fayre operator Whitbread (LSE:WTB) warned last month. Meanwhile the British Beer and Pub Association says pubs are closing at a record rate of six a day as beer sales seem in terminal decline, with a 6.3% drop in sales at pubs, bars and restaurants in this year's first quarter compared with last.
That adds up to 750,000 fewer pints a day being sold – or 68m fewer pints a year. And this was before the Budget's 2% alcohol duty hike.
Meanwhile, Punch is still saddled with the insidious hangover effect those massive borrowings have on the profit and loss account.
Here's what I mean. Overall revenue for the 28 weeks to 7th March fell by just over 5%, which translated into a 17% slide in operating profit. But the firm's interest bill swallowed up almost 70% of what was left, slashing earnings per share by over a third.
On that basis, a further 10% sales drop – which could well be on the menu, the way things are going - would more than wipe out the company's ongoing profit completely. And there's another problem. Somehow Punch has to find the money to repay a £209m bond next year. There's talk of a rights issue, i.e. rattling the tin to shareholders for some extra funds, but the company's hardly in a great position to launch one. And even if it did succeed, lots more shares sloshing around the market wouldn't do the stock price any good.
Where to invest in beer
So there's no chance of a near-term return to dividend payouts. And the shares look like they've run ahead of themselves – as often happens when there's a chink of light for a firm the market feared would fail. Rather than pile into Punch right now, I'd be much more tempted to cash in on that share price bounce to bail out.
But if you still like the idea of buying into beer, a better bet could be a brewer on the other side of the world. As our Jody Clarke mentioned recently (Profit from Latin America's growing taste for beer), the Santiago-based beverage business Compañia Cervecerias Unidas (NYSE:CCU) controls 86% of Chile's beer market. It's on a forward p/e of 13.6 times and 2009's first quarter sales increased 3.5% year-on-year. And even better – not unlike Chile itself - the company doesn't have a debt problem.
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