Marston’s (MARS.L) – The Pub Grub Hub
(This is the thirteenth installment in my series of case studies on the shares that make up my portfolio. To see the other twelve articles, on Ryanair, PetroNeft, Irish Continental Group, Independent News & Media, Total Produce, Abbey, Glanbia, Irish Life & Permanent, Datalex, Trinity Mirror and Datong, click on the company names)
Marston’s describes itself as “a leading independent brewing and pub retailing business operating a vertically integrated business model”. It has three business areas – (i) Marston’s Inns & Taverns, where it directly manages around 500 pubs; (ii) Marston’s Pub Company, which comprises around 1,650 tenanted and leased pubs; and (iii) Marston’s Beer Company, which comprises five breweries producing a range of premium cask and bottled beers, of which Hobgoblin and Wychwood are the best known.
Its strategy is to: (i) grow its estate of pubs through greenfield developments (the company aims to open 25 pub-restaurants in the current year), (ii) increase sales in its existing estate through a combination of its enhanced franchise model and what management calls ‘The F Plan’ – a focus on “food, families, females and forty/fifty somethings”. The F Plan is a response to changing consumer tastes in recent years (a general switch to the off-trade, the impact of the smoking ban etc.) and makes sound business sense – as evidenced by the rising average profit per pub in its Inns & Taverns division between FY08 and FY11 – £117k, £120k, £132k and £145k respectively. It would seem that attracting in more people who want to have a meal in a pub is more profitable than simply focusing on those for whom ‘eating is cheating’! In the firm’s latest trading update management revealed like-for-like food sales growth of 3.9% and like-for-like ‘wet sales’ growth of 3.4%. (iii) ‘Localness and Premium Brands in Brewing’ – revenue in its Beer division has gone from £84.1m in FY07 to £106.5m in FY11; and (iv) Cutting the net debt / EBITDA ratio – this has improved from 7.1x in FY09 to 5.7x in FY11, and I forecast that it will have improved further to 5.4x in FY12. This is certainly high, but the group has strong asset backing, with PPE of £2bn versus net debt of £1.1bn or so.
On building a model for the company, two things stood out – its operational excellence and its cash flow. I’ll focus on both of these in my analysis, before concluding with some valuation thoughts.
In terms of its operational qualities, Marston’s is an outstanding performer. As illustrated above, it has managed to lift average profitability across its estate at a time when the consumer has been under siege from a dismal economic backdrop. Its headline performance has been assisted by a clear willingness to divest under-performing assets. The group sold 25 pubs in the last financial year and over the previous 4 years it has raised just under £80m from the sale of assets. Marston’s is also adding pubs to its estate in other areas. The group opened 55 new pubs between FY05 and FY11, which are delivering an average return on investment of circa 17% and achieving average weekly takings of circa £23k. Post 2009 its new builds have been delivering average weekly turnover of £27k and pro-forma annual EBITDA of £400k, well ahead of management targets of £20k and £300k respectively. And I emphasise, this is in spite of very tough economic conditions. In its recent trading update, the group reported low-single digit growth across all business areas, and management expressed hope for good trading around events such as the Queen’s Diamond Jubilee and Euro 2012.
Cash flow is something that does concern me about Marston’s. At the end of FY11 Marston’s had net debt of £1.1bn, unchanged from the end-FY09 level, despite having generated £371m of operating cashflow over the period. Looking at the statements shows where this ended up – £170m in net capex, £66m in dividend payments and £144m going on interest payments.
Whatever about the interest payments (mandatory), and the capex (justified by high ROI), the dividend stands out as a particular anomaly to me. Based on where the shares are currently trading at (99.75p) Marston’s yields 5.8%. I wonder if shareholders would be better off if the company axed the dividend and pumped the money saved into either new build pubs, given their ROI of 17%, or on paying down debt – net finance costs / average net debt over the past 3 years have been a stable 6.9% per annum. If the latter, it would accelerate management’s goal of reducing the net debt / EBITDA ratio (I do find it interesting that the stated goal is to reduce the ratio as opposed to reduce the debt) and de-risk the company somewhat. If the former, I think it would greatly enhance shareholder value over time.
In terms of the valuation, I have opted for conservative revenue growth and margin estimates over the coming years, partly because of the troubled macro outlook and partly because I wonder if the group’s cash flows (after dividends and interest have been paid) may limit growth. I have come up with a blended valuation of 92.5p / share for the company, based on the average of a DCF model (68p/share), my end-2012 forecast NAV/share (£1.52) and a Dividend Discount Model (58p/share). I assume zero growth in dividends from here, which is conservative, but I don’t see any justification for raising the dividend given the factors noted above. At a price of 92.5p / share Marston’s trades on the following FY12 multiples (based off my forecasts) – 7.9x EV/EBITDA and 7.2x PE, while it would have a 6.3% dividend yield.
This valuation stands 7.2% below where the shares are presently at, however, I don’t think I’ll be rushing to the exit. This is due to four reasons – firstly, the dividend yield is one of the highest ones within my portfolio, and there’s no harm having some decent income generating stocks in it; secondly, there is some potential for positive surprises from factors such as Euro 2012 and a decent summer; thirdly, when the UK economy starts to pick up, Marston’s should outperform (from an operating perspective) as much on the upside as it has done on the downside; and fourthly, I think the downside risk is limited given the conservative assumptions built into my forecasts. But would I buy more? It’s a bit like consuming the ‘wet’ products Marston’s sells – there’s nothing wrong with having a few, but I wouldn’t want to have too many of them – given both the high level of debt and the valuation.