Stonegate – Portfolio pains
All,
Please find our marginally updated analysis here.
Although little has changed since our Q3 update in September, we decided to refresh our analysis and model. Stonegate Pubs is still dangling the carrot of a sale of a pub portfolio in front of investors, but the deal seems to be struggling to complete. We have chosen not to get involved in the capital structure, due to the leverage, and the cash flow headwinds from the UK economy. Management is looking to deal with the debt stack and profitability but is struggling.
Investment Considerations:
- We are not comfortable taking a position in Stonegate yet. The upside in the bonds is around 10 points, and the downside is 15 points plus.
- Our base and upside case for Sarria is an Amend and Extend (A&E). Trading in the 90s, the SSNs do not offer the type of returns we want to back an A&E. If either no sale happens or there is prevarication over executing an A&E, the downside in the bonds is at least 15 points given the size of the estate.
- The balance sheet value of the pub portfolio is £3,723m. If we assume a 5% cap rate is being used now and then increase that to 7%, the valuation falls by around £1bn to £2,759m. Senior debt is £2.8bn, if we applied a 65% LTV, we get an intrinsic value of 64p/£ for the SSNs.
- Stonegate will instead look to sell a leverage reduction in the future. Our modelling does show EBITDA improving through FYE25/26 with leverage falling to 6.5x (high but financeable). The valuation would start to rise on the basis of a higher gross rental basis, even if Cap rates take time to return to 5%.
- From recent press comments, it is also possible that Stonegate only manages to sell the £600m debt (at what price?), and is left with the £400m equity slice.
Executing a pub sale will be difficult, and is not an instant solution:
- The mooted sale of 800 pubs for £1bn is shifting, with press reports now talking of up to 1,000 pubs being sold (but no target price). The sale was expected to launch in September, but there is no word.
- We have been sceptical about this deal and feel the transaction will require splitting operations and ownership for sufficient debt to be raised.
- Management is targeting an 11x+ EBITDA multiple, but current pub multiples are closer to 7x – 8x. By splitting the property and the ownership, Stonegate could take advantage of cap rates that have remained stable. We estimated potential sales proceeds could be as high as £990m, but we were sceptical about who would step in.
Operational results are getting better overall:
- Q3 Revenue was in line with our model, and EBITDA margins were slightly ahead (23% vs. model at 21%). Stonegate attributed the better margins to lower energy costs. We had expected this to be a poor quarter, so this is a good performance. Operationally, the (urban-focused) branded bar business continues to struggle, impacted by poor weather and rail strikes.
- Leverage is coming down, but is too high to be refinanced right now. Our modelling points to leverage >6.5x on March 2025 when the bonds are due (>8x 12 months earlier). Leverage will only fall beneath 6x in 2027 on our modelling. The current LTV is c75% (it is lower in the Unique Pub Securitisation).
I look forward to discussing this with you all.
Aengus
T: +44 203 744 7055