Keep the faith – this company won’t be calling last orders anytime soon
The old adage “survival of the fittest” provides a pertinent description of the current state of play in the pub industry. After a disastrous couple of years caused by Covid lockdowns, pubs are now faced with a cost of living crisis that is showing little sign of abating.
Inflation is more than five times the Bank of England’s target, while the economy narrowly avoided a recession in the second half of last year. As a result, discretionary incomes are being relentlessly squeezed and consumer confidence is close to an all-time low.
These circumstances prompted the number of pubs in England and Wales to fall to a record low last year. It would be unsurprising for many more of the roughly 40,000 pubs still open to cease trading by the end of the current economic downturn.
A tough operating environment has weighed on pub group Young’s, which is a holding in Questor’s Inheritance Tax portfolio. Its shares are down 30pc since our notional purchase in October 2017 and, despite a recent surge, trade approximately 40pc below their pre-pandemic level.
In terms of survival, the company is far better placed than the vast majority of its rivals. Its net debt-to-equity ratio of 24pc means its net interest payments were covered a healthy seven times in the first half of the current financial year. This provides it with sufficient headroom to overcome a period of lower sales prompted by reduced demand.
By contrast, many other pub owners, large and small, are likely to have accumulated greater leverage during the era of low interest rates that has now come to an abrupt end. They could struggle to survive amid the twin threat of rising costs caused by high inflation and a cost-of-living crisis that is prompting many consumers to cut back on non-essential expenditure.
As ever, industry challenges for the many create opportunities to expand for the few. Young’s used its sound financial position to spend £14.2m on four acquisitions in the first half of the current financial year. It subsequently made two further freehold acquisitions following the year end and is likely to continue this trend as a growing number of rivals seek to sell up amid a challenging operating environment.
It also spent £14.5m on improving a number of its existing properties. This will help to maintain the appeal of its estate to consumers and differentiate it at a time when many peers simply do not have the available resources to conduct widespread capital expenditure. In doing so, the company will avoid an oft-experienced downward spiral where unprofitable pubs perennially postpone reinvestment in what ultimately becomes a race to the bottom.
Although Young’s reported a 25pc rise in sales and a 15pc increase in pre-tax profit in the first half of the current year, this column is realistic about its near-term financial prospects.
Certainly, a weak previous year’s trading prompted by ongoing Covid-related restrictions is likely to flatter performance in the current financial year. However, with the cost of living crisis ongoing and the economic outlook remaining uncertain, it would be unsurprising for the company’s financial and share price performance to come under a degree of pressure.
Likewise, its dividend per share growth rate of 20pc in the first half of the year is unlikely to prove sustainable over the long run.
Of course, the economic status quo will not last forever. The Bank of England, for example, expects inflation to drop to just 3pc by the start of next year. This will alleviate the cost-of-living crisis and, while an economic slowdown may persist over the coming months, history shows that growth will ultimately return.
Companies such as Young’s that are very likely to not only survive, but use tough operating conditions to strengthen their competitive position, will be the biggest beneficiaries of an improving economic and consumer outlook.
Trading on a price-to-book ratio of around 0.8, Young’s offers good value for money on a long-term view. Given its solid financial standing, sound investment strategy and improving competitive position, it remains a worthwhile holding in this column’s inheritance tax portfolio. Its share price is likely to remain volatile in the near term as the cost-of-living crisis and economic downturn play out. But it is set to generate attractive returns as trading conditions ultimately improve.
Questor says: hold
Share price at close: 780p
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