Pubs sector 'in a precarious state' - Citi

Many pub companies are in a "precarious state", Citi warned on Monday, as they have too much leverage and little surplus cash flow to bail themselves out as the increasingly indebted UK heads for a potential disorderly Brexit.

Citi downgraded JD Wetherspoon to ‘sell’ from ‘neutral’, while upgrading Mitchells & Butlers to 'neutral' from 'sell' but only on a valuation basis. Pub companies and restaurant groups were all given a 'sell' recommendation, except Greene King and Restaurant Group, which were seen as 'buy' opportunities also on valuation.

Analysts see two "major risks ahead" from a potentially disorderly Brexit process and the increasingly indebted nature of UK consumers, with the bank's economists expecting up to five percentage points slower growth in GDP over the two-three years following a disorderly Brexit.

"When combined with the increasingly indebted nature of UK households this suggests to us that there could be meaningful downside risks to forecasts."

While special event dining supports the high end of the sector and the growth in fast food and delivery supports the low end, "many listed operators risk being squeezed in the middle ground".

Restaurant capacity is "finally" contracting, with a 0.4% decline in the last 12 months "but CVA mechanisms are preventing a full scale shake out and in our view extending the pain".

"We believe that many of the operators have too much leverage and importantly little surplus cash flow with which to de-lever. As a result some operators are left in precarious state. Without a sharp improvement in consumer prospects it is hard to see how investors can look forward to stronger earnings or deleveraging, leaving limited prospects for share price performance."

As for Wetherspoon, after recent strong earnings growth has driven the shares higher than peers, analysts assume a normalisation of like-for-like sales growth and modest margin contraction will result in EPS growth to be more in line with the sector in the next five years, resulting in a new target price of 970p that is well below the previous 1,420p.