Marston's divi delight

Over the past decade, Marston’s has focused its growth efforts on its destination and premium estate, having bought or built 60 per cent of its near-400 such pubs in the period. While these pubs represent only about a quarter of the overall estate by number, nearly half of the group’s sales and profits came from these establishments last year. Their contribution should continue to increase, with 15 more openings planned in the year to the end of September 2018. Operating from such high-quality and young pubs could prove a major advantage for Marston’s in a tougher trading environment, as it should support pricing power and help attract increasingly choosy customers. This part of the business also benefits from offering accommodation, with 1,250 rooms available and further ‘lodge’ openings planned. So during a tough 12 months to the end of September 2017, like-for-like destination and premium sales nudged up 1 per cent, with overall sales 4.5 per cent ahead, and operating margin only slipped from 20.7 per cent to 20.3 per cent.

Marston’s should also benefit over coming years from the expansion of its brewing and distribution activities through the £55m acquisition of Charles Wells Brewing Company. The division now accounts for 15 per cent of earnings and controls about a fifth of both the packaged and cask ale markets. The acquisition added more than 30 beers to the Marston’s portfolio, and builds on a strategy to focus on premium, growth brands. The deal has also helped increase Marston’s position in London and the south-east, and presents the opportunity to expand its beer brands into Scotland. Importantly, at a time when rising costs are an issue, the integration of Charles Wells provides the potential for cost savings, with £2m currently pencilled in for 2018 and £4m for 2019.

The group’s taverns and leased-pub operations have also put in a credible performance and have benefited from Marston’s roll-out of its ‘franchise’ model and recent popularity of drink-led pubs. Indeed, there was some jubilation that the full-year results reported at the end of November did not prompt brokers to downgrade forecasts following a year in which many pub groups, including Marston’s, have seen expectations managed downwards. What’s more, the fact the first seven weeks of the new financial year have seen like-for-like growth gives grounds for optimism that even if the downgrade trend has not ended, at least the worst of it may have.

Nevertheless, the trading backdrop is undeniably tough, which puts debt levels into tighter focus. On the surface, net debt, at 6.2 times cash profit, is unsettling. But look a little deeper and the picture is brighter. Strip out the cost of leases and net debt stands at 4.7 times cash profits. With 2.6 times fixed charge cover, the company looks as though it is well placed to be able to meet its obligations to creditors. Furthermore, the freehold asset backing helps justify high levels of gearing at Marston’s and across the sector.

It’s also worth looking at how the debt is structured. Of the £1.3bn total net debt, £301m came from lease finance arrangements where long-term leases revert to freeholds at the end of the term. Meanwhile, £800m of debt is secured against pubs accounting for only 55 per cent of cash profits, which means a significant proportion of profits are not potentially on call to bondholders. On the dividend front, while earnings cover at 1.9 times is a little below the long-term target of two times, it looks healthy enough. And, while Marston’s tactic of funding growth with pub sale-and-leaseback agreements will not be to every investor’s taste, there is reassurance in forecasts that free cash flow will cover dividend payouts in the years ahead.

The outlook for the wider pub sector could prove better than many fear. The most recent Peach Tracker, which acts as a gauge of how pubs and restaurants in the UK are doing, showed like-for-like sales growth of 2.2 per cent in November, with a 1.2 per cent increase in restaurants and 2.8 per cent in pubs.