Capital Pub Company

Profiting from the downturn

By Stuart Watson
Article Date:   02-07-2008

Additional:    Information
Market:   AIM
Sector:   Restaurants, pubs
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  • 19-09-2007
  • 02-07-2008




    Tough times also present the greatest opportunities and many investors are always on the lookout for companies strong enough to invest through a downturn. Capital Pub looks like it could fit the bill.

    Itís been a tough year for any business that is remotely property related. Capital Pub Company, with a couple of dozen pubs spread across London, is a case in point. Despite decent results, its shares are now less than half the level at which they floated at last March.

    Tough times also present the greatest opportunities and many investors are always on the lookout for companies strong enough to invest through a downturn. Capital Pub looks like it could fit the bill. Itís aiming to double the size of its estate over the next three to five years and says it is well positioned to take advantage of any fall in pub valuations.

    Four pubs closing a day
    There are about 70,000 pubs in the UK but this number is shrinking. Itís reckoned that there were 600 closures in 2006 and 1,200 in 2007. This year around 4 pubs are closing each day and some analysts are predicting the total number of closures could end up being close to 2,000.

    The combined effect of smoking ban introduced in 2007 and the economic slowdown is causing the damage. The amount of alcohol weíre consuming is declining and weíre drinking a greater proportion at home due to cheap supermarket prices. Beer volumes in pubs are down around 8% on last year. Wine is doing a little better, but is still down by 4%.

    Many smaller pub operators have reported gloomy trading news in the last couple of weeks, such as Regent Inns and Adnams. Capital Pub has done rather better, benefiting from its focus on higher quality establishments. Helped by acquisitions, figures for the year ending March 2008 showed sales increasing by a third to £18.8m and operating profits up by a quarter to £3.9m. Current trading was said to be satisfactory.

    Capitalís history
    Capital Pub was originally an Enterprise Investment Scheme business, raising its first funds in 2001. The company stepped up in size in 2006 when it acquired 10 pubs from Spirit, funding most of the £31m cost through debt.
    The shares joined AIM in June 2007 at 165p although no new money was raised at the time. Since then 4 pubs have been bought and 3 have been sold. Capital now has 24 unbranded pubs, mostly in Central London, of which 21 are freehold. Its target market is over 25 years old and weekly sales run at around £15,000, split 80% liquor and 20% food. The high level of beer sales enables the company to get additional discounts and hence better profit margins.
    Capital aims to buy high-quality pubs which require little in the way of refurbishment, and recent purchases have cost between £1.75m and £3.75m. Sometimes the purchase costs can be reduced by selling off non-retail parts of the property, such as the second floor of the Worldís End in Finsbury Park which was disposed of for £0.5m. Capital reckons around 700 of the 9,000 pubs in Greater London are independent free houses and many of them would fit its acquisition criteria.

    Thereís a target of 12% EBITDA on the purchase cost of any new pub and Capital doesnít seem to be afraid to sell pubs that arenít producing this. For example, three pubs were sold in January of this year for £8.5m but their EBITDA was only £0.4m (although admittedly one was closed for refurbishment).  

    A second company called, would you believe, Capital Pub Company 2 was set up under the Enterprise Investment Scheme in 2004. This now has 9 pubs. Capital gets a management fee from #2, as they share the same directors, but this arrangement is coming to an end in August. As investors in #2 consider their exit plans, one possibility could be a purchase by Capital.

    One constraint on Capitalís expansion plans could be the level of debt it is carrying. It currently owes £30m of which £20m is fixed at an interest rate of 6.3%. No repayments are due until the end of 2009. Humberts valued the pub estate at £70m a year ago so the level of gearing isnít too excessive. Interest cover was just 2 times though, which may put off more cautious investors.

    Changes at the top
    Capital was founded by David Bruce and Clive Watson. Bruce developed both the Firkin and Slug & Lettuce chains. Watsonís background includes Regent Inns, Tup Inns and Tom Hoskins. Bruce however is now approaching his sixtieth birthday and has just decided to retire as Chief Executive although he will remain on the board as a non-executive. Watson, being a mere spring chicken of 47, will take up his role as Chief Executive.

    At the same time as Bruceís departure, the company announced that its finance director, David Kenyon, is leaving the business after less than a year to pursue career opportunities elsewhere. Itís a bit disconcerting to lose two directors, including a founder, at the same time. But Capital appears well placed to cope and confident it can do so. Bruce, Watson and the companyís Chairman all added to their shareholdings during the Spring at prices between 89p and 117.5p.

    Capital is valued at around 10 times profits for the year just ended. The dividend was 3.15p which translates into a yield of 4%. Despite the industryís troubles, profits could advance this year. Capital negotiated new supply agreements which came into effect in March and should boost gross margins. Refurbishment of recently acquired pubs is now complete and should boost sales. Although there will only be a few monthsí worth of management fees from #2, this was said to be more than compensated for by recent Head Office savings.

    The biggest hurdle Capital faces looks to be financing any expansion. There will undoubtedly be bargains coming up over the next year or two, but Capital debt levels mean it may not be able to exploit as many opportunities as it would like.

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