Pub operator City Pub (LON:CPC) lost 20% of its market capitalisation in early trade this morning. The culprits were multiple factors as a City Pub Group profit warning was posted. The market shrugged this off quite easily from an initial markdown of 20%:
We have less share price history, as City Pub is a relatively new listing. It IPO’d towards the back of 2017. Since then the share price has gone up a little, but today’s warning takes it more or less back to where it started.
City Pub Group may be therefore a new name to investors. However, a look at its portfolio page should reveal some more familiar locations. The company owns and operates many distinctive and well-known public houses, some of which also feature overnight accommodation. The share has always been expensive in its time on the market. Perhaps a reason for the investor appetite is the fact that they have sought to keep original features and preserve history. This is at odds with other operators who seek generic, cookie-cutter properties.
What did the City Pub Group profit warning say?
The damage is done in a year-end post trading update. We have good news to start: year-on-year sales are up 31% and like-for-like, 1.7%. Then the bad news:
Having traded well over the majority of the year, frustratingly, a number of one-off factors combined in the latter part of Q4 which subdued trading over the important festive period. The Rugby World Cup did not have the impact that we expected. Political uncertainty culminating in the December Election held back sales until the result was known and unhelpful weather during November and December dampened trading further. There were also disruptions on South West trains throughout December due to industrial action, which had an impact on our London Estate.
Some of these reasons seem hard to believe. Would there be anyone that refused to go to the pub because of the General Election? The Rugby World Cup was cited because of the unsociable kick-off times of matches, but wouldn’t this be known?
Thankfully the impact is quantified:
Consequently, due to the one-off factors explained above, adjusted EBITDA (before exceptional items) for the year ended 29 December 2019 is now expected to be slightly below market expectations at between £9.1m and £9.2m, approximately 15% ahead of the prior year.
In a research note (available on Research Tree), this downgrade appears to be from a previous estimate of £10m. This means a 10% miss: so the share price fall may be commensurate.
City Pub: Growth in a Tough Market
Growth has been the word so far for City Pub in its short existence. Revenues are set to grow over 400% in the space of just a few years:
The main driver of growth has been expansion, and acquiring other pubs to run. The IPO raised £34.6m, which allowed a repayment of debt and bonuses for the founders. This put the company in a net cash position but quite quickly this has been wiped out by more debt as it keeps expanding.
So we have a position where on paper, we have profits. But there are a significant amount of capital expenditures which wipe these out:
Surprisingly as well, the company are paying out dividends without the cashflow supporting them. This is a move that Revolution Bars made until it found out that it could not afford both capex expansion costs and dividends. As a result, both had to be cut.
The capex numbers may look scary at this point. It has been balanced out by both debt and IPO cash and the fact that it purchases a real tangible asset which may have a greater resale value. Approximately half their pubs are held on freeholds, which contributes to a very strong balance sheet. Over £100m of assets, and £21.6m of liabilities.
The question may be where this ends up. The company is still in growth mode. It targets between 65-70 sites by the end of 2021 (currently 50). Borrowings are currently financed by a revolving credit facility secured by property. This value is £30m, but clearly this figure has to increase in order to meet that target. Such a financial structure appears pretty much standard for the industry. Many of the larger chains like JD Wetherspoon are financed this way.
Geographically City Pub have large concentration in the South of England. There are several properties around the more affluent cities such as London, Bath, Cambridge, Bristol and so on. With the number of pubs around the country reducing, this may lead to further opportunities as time goes on.
Is the City Pub Group profit warning an opportunity?
Personally I am averse to investing in this sector. We have headwinds on both the supply and demand side. People are drinking less (although this may not necessarily affect City Pub as much as they also offer accommodation and food). On the other side is the rising level of input costs. The minimum wage is increasing, and will continue to increase. It is evident throughout the industry that these costs have to be passed on to consumers. But with a like-for-like growth of just 1.7%, more needs to be done on this front.
The reported profits of £2m could be said to be a bit larger in real life, as this includes exceptional pre-opening costs. The adjusted profit before tax of £5.1m is more like it. However, at the current market capitalisation of over £110m, this is a very high multiple to pay and demands more growth.
Capital expenditures are very high whilst the company is in expansion mode. They have helpfully separated out expansionary capex, and the spend on existing sites is £5.8m or approximately £100,000 per site. I would view a good proportion of this charge as essential maintenance. A property falling behind the times can quickly lose reputation and patronage. Thus this is more of a natural drag on profitability.
It is very easy to admire what City Pub are doing, and how they are doing it. They have a portfolio of properties of which many are freehold, giving rise to a strong balance sheet and there is clear room for expansion. I don’t believe the shares offer great value for money though and even after today’s drop still appear quite expensive. 2/5.