Mitchells & Butlers competition squeeze

Mitchells, which owns brands including Harvester, Toby Carvery and O'Neill's, has a new chief executive in Phil Urban, who in his first set of results restored the dividend. The company had not paid money out to shareholders in this way since 2008, so the move was a real show of confidence. Indeed, the fact management feels the company, which has net debt equivalent to 4.3 times cash profit, can now afford to pay dividends is encouraging, but there's also plenty of reason for uncertainty about the outlook.

Competition has significantly stepped up in the eating and drinking-out market with 5,000 net new openings between 2012 and 2015, including about 2,000 in 2015 alone. Mitchells says more than half its food-focused Harvester and Toby Carvery outlets have come under pressure from competition. This is a worry as a pub chain's food offering is often its higher-margin activity. This has the potential to reduce the returns from Mitchells' investments in its estate while also making investment more necessary for the group to simply hold its own.

The worsening trading environment was reflected in a tailing-off of like-for-like sales growth towards the end of Mitchells' last financial year. That was followed by a 1.6 per cent like-for-like slump in October and November. Despite a Christmas pick up, the first quarter as a whole saw a 1 per cent like-for-like sales drop, which broker Numis points out was below the pub industry average of 1 per cent growth reported by Coffer Peach Tracker.

With rivals muscling in on its turf while management looks to upscale some of its smaller brands and convert sites acquired as part of its purchase of Orchid to its own stable, Mitchells may need to increase its capital expenditure, which has held steady at £162m over the last two years. Part of this spending is likely to be targeted at a strategy of investing in the company's smaller, high-value brands, such as Miller & Carter. However, as the Miller steakhouse concept only operates in 36 sites, reinvigorating Mitchells this way won't be an overnight story.

The tough recent trading has been reflected in broker downgrades. Numis, for example, cut its pre-tax profit forecasts by 3 per cent late last month. We can see the potential for more downgrades to come, especially with the introduction of the National Living Wage. If Mitchells is fighting competition, it might struggle to raise prices come April when the legislation kicks in.

On the plus side, cash flow has been improving. The company boosted free cash flow by £31m last year to £133m and generated adjusted net cash of £89m. Still, net debt of £1.9bn coupled with a pension deficit estimated by Numis at £441m is likely to keep the balance sheet in focus. That said, debt should be seen in light of the £4.2bn of property.