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Spirit primed to re-rate

Spirit Pub Company (SPRT) can offer investors further upside as its turnaround story following a spin out from Punch Taverns (PUB) continues.
May 1, 2014

Following its demerger from debt-ladened Punch Taverns (PUB) in 2011, Spirit Pub Company (SPRT) has focused on reinvigorating its key managed-pub brands while reducing and refinancing its substantial debt pile. But despite the impressive growth this strategy has produced, the shares still trade at a substantial discount to those of peers. With management's focus now shifting towards a longer-term growth strategy of expanding its branded estate, as well as continuing to improve the performance of its leased pubs, we believe the shares will re-rate.

IC TIP: Buy at 79p
Tip style
Growth
Risk rating
Medium
Timescale
Long Term
Bull points
  • • Strong half-year results
  • • Managed estate expansion plans
  • • Growing dividend policy
  • • Strong brands
Bear points
  • • High debt
  • • Reliant on consumer demand

An impressive set of half-year results show the consolidation period for Spirit following its demerger from Punch is nearly complete. Importantly, with net debt now in the region of £750m, chief executive Mike Tye says he is "comfortable" with the company's borrowings, especially following a refinancing at the end of last year. According to Mr Tye, the debt repayment schedule is now "evenly spread over the next 20 years" making the covenants "much more realistic".

Given this progress, we'd expect the attention of investors to increasingly shift to Spirit's underlying performance. Since the demerger, Spirit has had to rethink how its runs the leased-pub side of its business while improving the quality and earnings of the managed estate. The progress is clear to see. Half-year figures recorded a 5 per cent increase in like-for-like sales in the managed estate and a 30 basis points rise in cash-profit margins excluding rent costs (EBITDAR margin). This takes the sales growth from the managed estate over the last three years to 12 per cent. What's more, like-for-like growth has consistently outperformed the industry benchmark, Coffer Peach Tracker.

The growth has been achieved by focused investment, particularly into the group's brands, such as Taylor Walker, Fayre & Square, Flaming Grill, John Barras and Chef & Brewer. Indeed, during the first half Spirit completed 19 investment projects in its managed properties, including the conversion of three leased pubs to managed and branded formats. That said, the average investment spend was only £140,000, illustrating the the disciplined approach the group has taken towards capital spending which is helping to drive very impressive returns. The proportion of Spirit's managed estate that is 'invested' and branded has reached 87 per cent and the average return on investment now exceeds 25 per cent.

This investment programme has been key to driving profit and sales growth over recent years, as well as pushing up the price of Spirit's shares. But with the process almost complete, the question now is where future upside lies for the group's shareholders. The answer largely comes down to building on the success of its brands by expanding the estate. This may prove a rather vexing prospect for some investors who remember the calamity that befell Punch when the credit bubble popped following several years of debt-fuelled expansion. In fact, both before and following the demerger of Spirit, Punch has been forced to sell off many of its prize assets in order to service debt and shareholder value is now in the balance pending the outcome of negotiations with bond holders.

Of course, Spirit's management says that this time it's different. But we are genuinely reassured by the fact that Spirit's expansion plans do seem relatively modest. Mr Tye, who had formerly been at Whitbread before taking over running Punch's managed estate in 2008, insists the group will only grow "at a pace which finances will allow". On the managed side, Flaming Grill could see the number of sites doubled via the conversion of the current properties along new site acquisitions while Fayre & Square will look to leverage its children's play brand 'Wacky Warehouse'. Importantly, expansion is not expected to compromise the progress already made with sales and margin growth across the managed estate.

Further upside for investors will come from the leased estate which is still being 'optimised' after years of poor performance. More than 96 disposals have been made on the leased side and each pub now contributes average income of £101,000. Supply network issues are still a problem, but Mr Tye argues the leased division is an "increasingly valuable business".

SPIRIT PUB COMPANY (SPRT)

ORD PRICE:79pMARKET VALUE:£521.7m
TOUCH:78-79p12-MONTH HIGH:88pLOW: 62p
DIVIDEND YIELD:3.1%PE RATIO:11
NET ASSET VALUE:86p*NET DEBT:133%

Year to 17 AugTurnover (£m)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
201173444.05.3nil
201276051.15.81.95
201375854.36.32.05
2014**78057.96.82.22
2015**78661.27.22.41
% change+1+6+6+9

Normal market size: 5,000

Matched bargain trading

Beta: 0.72

*Includes intangible assets of £214m, or 32p a share

**Based on Numis forecasts, adjusted PTP and EPS figures