Pub companies crying into their beer after consumer and competition warning

Pub companies and analysts were gasping after a warning from brewer Greene King about falling sales, rising competition and costs, all set against a worrying backdrop of tightening consumer belts.

Greene King reported a weakening in pub company like-for-like sales over the last four and a half months with trading deteriorating since July.

Shares in the Bury St Edmonds group were down more than 14% in early trading on Friday, with peers Mitchells & Butler, EI Group (the former Enterprise Inns), JD Wetherspoon, Fuller Smith & Turner and most of all Marston's all pulled down with it.

The trading update was another sign of the UK weakness in consumer spending and confidence, said analyst Neil Wilson at ETX Capital

He expect a return to year-on-year growth for Greene King and its peers this time next year when the World Cup comes into play but said it was "yet another sign that the squeeze on consumer spending is hitting company profits".

Jamie Constable at N+1 Singer said investors "always raise an eyebrow when a company blames the weather" and said there was also negative read-across in the leisure sector to Restaurant Group.

He felt that the most worrying aspect of today's update is reference to the 'value' segment being pressurised, "effectively referencing their dominant Hungry Horse brand which looks to have gone ex-growth... is this the next Frankie & Benny's?".

DIVIDEND AND EARNINGS DOWNGRADES

Constable said the warning further explains why Greene King acquired Spirit -- "they needed it!" -- and wondered if investors will start to question the sustainability of its dividends, which are covered 1.7 times based on free cash flow but excludes expansionary capex as it is discretionary. "If you include this, Marston's DPS is uncovered and GNK just about covered."

Investec's Karl Burns downgraded his Greene King earnings per share estimates by circa 3-7% for the current and next two financial years and cut his rating on the shares based on a lower target price of 667p.

With the market seemingly worsening, Burns reduced his managed LFL sales growth rate to just 0.5% from 1.5% for the current year and to 1.0% for 2019-20, which fed through to the lower our EPS estimates.

"With limited EPS momentum given the weak LFL backdrop and high cost pressure, squeezing margins, we see little catalyst for a change in momentum. Whilst the dividend yield should provide some support to the share price, we downgrade our recommendation to 'hold'."

Analysts at Citi took a more cautious view for the pub and restaurant sector over a year ago due to perceived downside risks
to consumer confidence and increased cost pressures and continue to hold this view, they said on Friday, supported by in-house analysis that points to ongoing weakness in spend through the remainder of 2017 and into 2018.

Although, reflecting this caution, Citi has 'sell' recommendations on EI Group, Marstons and Mitchells & Butlers, a 'neutral' recommendation on JD Wetherspoon, Greene King is the bank's only 'buy' in the pub sector reflecting its freehold asset backing, prudent balance sheet structure and robust cash flow.

Citi, while cutting its full year Greene King pub LFL forecasts to -1% from +1% and its target price to 800p from 860p, likes the stock for its 8% free cash flow yield and 5% dividend yield, compared to peers FCF at circa 6% and DPY 3.5%.

WIDER CONSUMER CONCERNS

While investors may be tempted to dismiss one or two company profit warnings as down to ‘company-specific’ problems, with Greene King blaming the summer weather, the disappointing sales came on the same day as a genuine profit warning from Safestyle and follows a warning earlier in the week from casual dining chain Fulham Shore.

Add to this picture an ongoing slide in UK car sales, said Russ Mould, investment director at AJ Bell, "and it requires little imagination to build a picture where weak wage growth and lofty levels of credit card debt are combining to depress consumer spending and confidence, to the potential detriment of growth across the wider UK economy".

Small-ticket discretionary items are coming under pressure, such as home improvements and eating out, as well as bigger-ticket purchases such as cars, as consumers watch their outgoings more closely.

“Such a picture will hardly encourage the Bank of England to pull the trigger on an interest rate increase any time soon and it would be a massive surprise were the Monetary Policy Committee to even hint at an increase in headline borrowing costs at the meeting set for Thursday 14 September,” Mould added.