Punch - How LTV limits CF

All,

Please find our updated analysis on Punch Taverns here.

We remain bystanders, preferring to watch the very slow-motion game instead of taking part. Ahead of results on Friday, we have updated our analysis of the Fortress owned group. Q123, having shown encouraging sales trends, was the first to reflect the new energy contract. With the group performing broadly in line with our projections, Fortress’ three-year task is becoming clearer and more pressing as the group looks unlikely to grow into its capital structure by passing on inflation alone.

Investment Considerations:

- We are still not interested. Punch’s bonds have good downside protection - even if their language is weak in comparison to more traditional REITs. On the upside, however, the story remains an equity saga, as so far only very few pubs have been converted from L&T to MP. WE might change our view if we saw a pick-up in conversion rate, but while it is this low it is hard to justify the courage.

- Punch are probably dragging their feet, because to fund conversions the company has to sell pubs first, which could require impairments in this market and put further pressure on the already (still) high LTV. 

Q123 (Dec. 22):

- The 16-week quarter (every Q1 has 16 weeks) only provides limited sequential comparability, but it was broadly in line with expectations. Margins were lower than in most of 2022, primarily due to the new energy contract having taken effect from September 22. Note that a new gas contracts comes into effect in 2025.

- Meanwhile, WC and CapEx came in close to model and cash conversion was good - as usual. 

- In the end though, the rise in sales could not lift the –£25m NCF deficit it currently produces on a largely normalised basis.

Outlook:

- We are concerned that Q1 could be a little bit weaker again. The weather has been miserable, economic uncertainty among the general public remained high and there were no coronations/funerals or jubilees to raise revenue.

- We think it could take time for pubs and pub groups to pass on the full cost inflation they are experiencing, because of the very level playing field that selling beer represents.

- The bonds are due in 2026 - now only three years away, which gives Punch approx. two years to show improvement worth well over 5% of top line. That seems like Fortress need to double down on their strategy to convert L&T pubs to MPs and we fear that part of the solution may have to come from the sponsor. Note that this line of thinking is based on cashflow and interest coverage. 

- From an LTV perspective Punch remain just under 70%, again too high for a straight refinancing. However, if yields play out the way the curve is still inverted, then book values might rise again before 2026 and help bring this metric down. 

Fortress’ position:

- The sponsor should be able and willing to defend its investment with - if it came to it - a cash injection worth 10% - 15% of its investment. However, such investments are typically not made long before the refinancing, so until then bonds should be sweating a little more.

- Punch could therefore become interesting in the medium term, but three years from maturity with a soft quarter ahead, we are not in a rush to bet on sponsor support.

Happy to discuss,

Wolfgang

E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk