M&B goes up market

Life has not been the same for pubs operator Mitchells & Butlers (M&B) since Bahamas-based billionaire Joe Lewis bought a 23 per cent stake two years ago. Mr Lewis’s arrival triggered a board room battle and ultimately a purge of M&B's bosses. The new regime, supported by Mr Lewis, set out its stall in March with a new business plan.

The key aims are that M&B should expand its food offering, improve profitability (a 2 to 3 percentage point rise on 2009's profit margins over three years is the target) and keep debt at a level with which the City would feel comfortable (not more than five times cash profits). A key first step in realising these ambitions was to sell off non-core businesses, which included 333 down-market pubs, bowling allies and budget hotels. This has pretty much been achieved, with proceeds of £500m realised from the disposals.

Some City analysts didn’t believe progress would be so swift, but the group has now moved to the expansion phase of its plan. In September, M&B acquired the Ha Ha Bar & Grill for £19m to convert its outlets into its own successful brands, and has bought other individual sites since. The focus on the group’s best brands, such as Toby Carvery and Harvester, looks sensible. M&B has long been credited with being one of the best pubs operators in the UK and its expansion plans should capitalise on that. Management also plans to up its capital spending to £200m in 2010-11, compared with about £131m in the year just ended, a figure that included £20m on expansion.

Because M&B will be focusing on brands that are further up market than the ones it has sold, it should be in a strong position to pass on cost increases to customers, and trade should be less exposed to weakness in consumer spending.

In a trading update for the 51 weeks to the 18 September, M&B said its like-for-like sales were up 2 per cent year-on-year overall, but were 2.8 per cent higher in its core estate. Encouragingly, the figures for the final nine weeks of the period were stronger still - 3.6 per cent up overall and 4.4 per cent in the core estate. Meanwhile, operating profit margins for 2009-10 are expected to be about 1.2 percentage points higher at 16.5 per cent. Management aims to improve buying, and cut waste and overheads to achieve its targeted margin of 17 to 18 per cent.

It also plans to take on more leasehold properties to speed up its expansion. M&B found that its managers had been concentrating too much on managing a freehold estate. To change this, M&B is splitting itself into an operating company and a property company, with the pubs paying rent to the property company. The hope is this will encourage management to focus on money-making formats. It could also lead to the sale of freeholds that are not pulling their weight.

The group’s debt, although high, is not putting pressure on M&B to sell property. Most of the group's £2.6bn of debt is locked safely in a relatively low-cost securitisation. Excluding that, the group has net cash following the sale of non-core assets.

We think Mitchells could be onto a winner with its new plans and, now disposals have been made, the seeds for long-term growth are being sown. Positive surprises should also keep coming through as M&B continues to raise its profits margins, which some City analysts have barely factored into their profit forecasts. However, the stock market does not seem so keen on M&B's shares - their price has underperformed the FTSE All-Share index in recent months. Yet broker Peel Hunt points out that, with an enterprise value (equity plus net debt) of just 7.4 times forecast cash profits, M&B is among the cheapest of the quoted pubs operators.