Pubs, pints and profits – promising future ahead?

Pubs are part of the UK's cultural furniture and are important social hubs across the land. The last year has not been easy though, as government restrictions have forced bars to close or serve at reduced capacity for much of the year. Now it looks like the worst is behind us, so focus must turn to the future.

With society beginning to normalise, we could be in for a bumper summer. After being stuck at home for so long, punters are likely to be keen to get back to their local, and a rising tide will lift all boats. This means the next few months will be crucial as pubs and restaurants look to rekindle customer relationships and battle for market share.

We've added two of the country's leading publicans to our share research coverage: JD Wetherspoon and Mitchells and Butlers. But we'd like to assure readers that our initiating pub coverage just as government guidelines allow for field research is purely a coincidence.

This article isn't personal advice. If you're not sure if an investment is right for you, please speak to a financial adviser. All investments rise and fall in value, so you could get back less than you invest. Past performance is not a guide to the future.

Investing in individual companies isn't right for everyone. You should make sure you understand the companies you're investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

JD Wetherspoon

JD Wetherspoon, or Spoons to most of us, is a purveyor of cheap pints and pub food across the country. The group operates 872 pubs and in normal times generates 96% of its revenue through bar and food sales.

In the year ending 28 July 2019 Spoons recorded £1.8bn in revenue, although the pandemic has severely reduced this – revenue was down 30.6% in the year ending 26 July 2020 and 53.8% for the half year ending 24 January 2021.

JD Wetherspoon Revenue 2019

Scroll across to see the full chart.

Source: Annual Report 2020.

A focus on providing good value means Spoons' margins are below competitors'. In 2019 the operating profit margin was just 7.3% before exceptional items, behind many peers. Low margins aren't necessarily a bad thing, and many successful businesses have followed a "pile em' high, sell em' cheap" approach. Nonetheless, it does mean Spoons rides slightly closer to the edge than some competitors.

And the last year hasn't been fun. Spoons made a full year loss of £97.6m in the year ending in July 2020, and lost another £61.4m in the six months to January 2021.

The group turned to investors to shore up the balance sheet this year and, after raising an extra £235m, net debt (readily available assets minus debt) stands at £811.9m. Management intends to keep this at around 3.5 times cash profits for the foreseeable future, but recognises that 0-2 times is probably optimal long term.

We understand that interest rates are low at the moment, so the interest costs of a high debt load are lower than they might have been historically. But still, we'd like to see debt come down.

However, 64.4% of Spoons' pubs are freeholds, giving the group a substantial property portfolio. The balance sheet lists £1.1bn in freehold and long leasehold property – and it hasn't been revalued in some time.

Spoons' chairman, Tim Martin, is a polarising character thanks to his support for Brexit and colourful updates for shareholders. This wouldn't matter much, except that JD Wetherspoon doesn't conform with some elements of the UK Corporate Governance Code. The group has explained that it doesn't agree with the guidance on the length of board member tenure, board member independence, or the relative importance of shareholder engagement.

Ultimately, investors will have to make up their own minds on this issue. A degree of non-conformism often looks like genius when things are going well, but if things go badly it's never a good look – especially if there's some sort of governance failure. For us it's not a deal breaker, but it does warrant extra scrutiny.

In our expert and thoroughly researched view, pints are too expensive, especially in some of the major cities. Cheap and cheerful pub fare is therefore an attractive offering, even if the Spoons atmosphere isn't to everyone's taste.

We think this puts the group in a strong position, and the extensive property portfolio is another bonus. We'd like to see debt come down, but if everything goes to plan this summer, the group should be able to work on that.

Spoons shares currently change hands for 5.3 times book value, which is well above the long-term average. The group is not currently paying a dividend.

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Mitchells and Butlers

Mitchells and Butlers (M&B) is one of the UK's leading pub and restaurant companies. The group operates across 15 brands and formats at around 1,660 sites, and 82% of the population lives within five miles of one of them. The group's brands include O'Neill's, Browns and Miller & Carters.

Overall, we think it's a decent portfolio, but none of the brands are quite in the top tier. However, the group is well diversified across demographics and geographies within its sector, which offers some protection against changing tastes.

In the year ending 26 September 2019 revenue was £2.2bn, which fell to £1.5bn in 2020. On an adjusted basis operating margins were 14.2% – almost double Wetherspoons'. Healthy margins are always nice to see and could speak to the strength of some of the group's brands. We certainly hope to see the company recover to this level as conditions normalise.

As of September 2020, net debt stood at £1.6bn excluding lease liabilities, which was roughly flat on the year before. In 2019 net debt was around 3.6 times adjusted cash profit. M&B has since raised gross proceeds of £351m by issuing new shares, which will help relieve some pressure. In the long term, we'd like to see debt come down a little further still.

82% of the group's sites are freeholds, and the balance sheet boasts £3.8bn in property assets – although there's a fair degree of uncertainty in the valuation given the events of the last year.

M&B offers a different kind of pub and restaurant investment than Wetherspoons. Instead of one very well-known brand, the group operates across several – most of which are at a slightly higher price point.

M&B boasts stronger margins, but we worry the lack of significant brand strength means the group might struggle to meaningfully differentiate itself from the wider sector. However, M&B is well diversified, which could offer some shelter.

M&B shares can be bought for 0.9 times book value, which is broadly in line with the long run average. The group will not be paying a dividend until September 2021 at the earliest.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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