Stonegate Pubs – Brave
All,
Please find our amended analysis here.
Despite the worsening the Going Concern language in its Annual Report, our model shows Stonegate Pubs will not need fresh cash. So far, Stonegate has substantially recovered cost headwinds through price rises and menu changes. Price rises in its estate over the last two quarters equate to about 2% of our projected FY23 revenue. We do not anticipate a need for cash in 2023 (this would be within the RCF amounts). A severe economic downturn in the second half of calendar 2023 would prompt us to look at the model again. We think the press speculation of a £1bn sale of 800 pubs is just that, speculation. Stonegate may be keen at this point, but we cannot see a transaction of this size in the current environment.
Investment Considerations:
- We have not invested in Stonegate yet, but we like any business where most of its £3bn in pub assets are freehold leaving plenty of levers to pull for liquidity if needed. Going long pubs now is a leap of faith we are not willing to make until we see the results of the trading period to mid-January (due 9 April 23). Pub closures are at 10-year highs. In the short run, this reduces competition and boots chains, but the impact of cost rises impacts the entire market. Also, it is not a great time to be in the market with a rumoured 800 pubs for sale for £1bn.
- It’ll get worse before it gets better. We expect rising leverage in 2023 as cost headwinds hurt EBITDA and Stonegate struggles to pass the full increase to publicans. As the UK economy improves in 2024, we see EBITDA growth returning leverage to previous levels.
The change in Going Concern language is a worry but well outside our forecasts:
- Stonegate’s going concern language in the annual report now warns that in its “severe but plausible” case, cash would be required in July/August 2023 and January/February 2024, and there would be an RCF covenant breach in July 23.
- Our model forecasts modest top-line growth in 2023, but with headwinds reducing EBITDA margins from 25% to 22% as we are doubtful that Stonegate can fully pass price rises to Publicans who are already feeling the pinch. We have cut our capex from £100m to £60m to reflect a lower level of pub conversions. The post covid working capital outflows in Q1 22 will not be repeated, and we model for only a modest inflow.
- Stonegate’s base case expects utility costs to double but for trading to return to pre-covid level along with cuts in Capex. Stonegate will be managed for cash.
- The downside case for Stonegate would require:
Revenue to fall 5%. Stonegate has had success in getting price rises through so far.
An additional 50% rise in utility prices from mid-24. UK Forward energy prices are at similar levels to before the Russian invasion of Ukraine. Another energy shock is plausible, but it is not yet part of our base case.
Headwinds strengthening but manageable:
- Between Q3 and Q4 the expected cost headwinds rose from £45m to £51m for FY2023. Wholesale electricity prices are falling but remain elevated. Food inflation is also reducing but not disappearing. Staff costs are not going to reduce anytime soon.
- Stonegate has successfully recovered most of the cost headwinds via higher prices for drinks (and more upselling) and reducing menu costs (but not prices).
- Demand is holding up with our model projecting growth of around 5% (3% volume, 2% pricing).
- Because the large L&T business does not ultimately look through to the end consumer, we are gauging economics via the Managed estate and the independent pub sector. The latter is feeling pain (especially at community pubs). In the long run, Stonegate will benefit from the reduced competition. But in the short term this will dampen revenue.
Stonegate FCF will be broadly flat in 2023:
- We have altered our model to reflect management’s shift towards cash preservation, and despite the headwinds, we expect Stonegate to generate net cash this year.
- There is a £137m maturity under the Unique pub securitisation. Refinancing should not be challenging given the level of over-collateralization in the structure, albeit with an increased coupon.
- Refinance via additional issuance should be straightforward given the excess collateral within in the structure, albeit the coupon will be higher.
- Alternatively, Stonegate could also use cash on hand and RCF drawings to repay this bond. In this case net cash use would be around £116m.
I look forward to discussing this with you all,
Aengus
T: +44 203 744 7055