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There were glum faces round the bar last week. A so-so Budget for the pub trade was followed by Mitchells & Butlers, the UK’s second-largest tavern ale house operator, saying it would hold back its next dividend.
“We need to keep our powder dry,” says Phil Urban, chief executive of M&B and proprietor of Harvester and Ember Inns. “We are in uncharted waters”. First it was recession, then austerity, followed by the Brexit vote and now “the fragility of the political climate. If there is a snap election, we’d look stupid if we hadn’t thought about it”.
The Budget itself could have been worse for the sector. Alcohol duty was frozen except on super-strength ciders. The chancellor also eased up on business rate increases, and the rise in the national living wage was lower than Mr Urban had pencilled in. However, “the macro environment is more difficult to read than ever”, he says.
His thoughts were echoed by Simon Emeny, head of the smaller London-based Fuller, Smith & Turner, on Friday. Mr Emeny talked of “unprecedented influences on the business . . . I cannot remember a time when we have faced such an array of additional cost pressures”.
Fuller’s shares were pretty much unchanged over the week, unlike M&B’s shares which fell nearly 6 per cent. In contrast, shares in the City Pub Group, the smallest listed company in the sector, rose 6.5 per cent on their junior market debut last week.
The City Pub Group raised just £35m to double its estate from 34 hostelries and couldn’t be more different from M&B. Its sales are “wet-led”. That is, 70 per cent of its revenues come from liquor and 30 per cent from serving food. Clive Watson, founder-chairman, says he can earn more from selling pricey craft ales than he would serving pie and peas. That probably makes sense for a small company focused on urban centres, where the trade is always passing through. Tables take up valuable standing room, kitting out kitchens in high-rent locations is expensive and eateries need troops of staff to cook and serve food.
M&B operates on an altogether wider canvas. It has a 40,000-strong army of bartenders, waiters and chefs running its 1,750 pubs and restaurants across the UK. That puts it at the sharp end of broad shifts in consumer spending, inflation, wages, and import costs.
Some 53 per cent of its sales are “dry”. M&B is about the most food-led among its bigger rivals, most of which have been moving from selling booze to food. If people drink at all, nowadays, they are as likely to pick up a six pack at the supermarket than frequent an ale house. Beer sales have fallen from 140.5m barrels a year in 2000 to 107.5m in 2016, according to Moody’s, the rating agency. Not even the vogue for craft beers has changed the general trend.
And it has worked. Shifting from pints to plates has lifted profit margins. The mark-up on a pint of beer is higher, but bar staff have to pull a lot of pints to earn the equivalent of feeding Sunday lunch to a family of four.
However, the balance may be tipping back. People are eating out less frequently, the restaurant sector is more competitive, the capex for converting tap rooms into gastropubs is high and recent cost increases have squeezed margins and cash flow.
Investec analysts say M&B would have to increase like-for-like sales by more than 3 per cent a year to keep profits flat. In the year to September, M&B managed to lift like-for-like revenues by 1.8 per cent, with beer outstripping food sales’ growth. Prettified pre-tax profits fell 0.6 per cent to £180m. Returns on capital are being dragged down by the group’s pension deficit of £451m and its net debt of £1.75bn, which is about 4.3 times earnings before interest, tax and accounting nasties.
M&B is not alone, warns Moody’s. Free cash flow and balance sheets across the sector show signs of weakening.
That will leave many tavern boards tossing up between paying off debt, spending on estates or handing cash to shareholders. Mr Urban believes M&B would be throwing away market share if he abandons capex. “We have to invest. It would be naive not to”. His peers may agree. He may not be alone in ringing the bell on dividends and telling investors: “Time gentleman please”.