While the pub sector is showing signs of stabilisation after a number of difficult years of trading, there is still cause for concern for operators. Those who cannot react quickly to change should be particularly wary.
In recent years the licensed trade industry has suffered from the triple whammy of changes in government legislation (e.g. the smoking ban), falling consumer confidence and the recession. Price competition, driven in particular by oversupply and supermarket discounting as well as increasing costs (e.g. beer duty, business rates, wages and utilities) has had a sobering effect on gross margins.
Stable but fragile
2012 has seen some stabilisation in the industry, at least partly due to the exodus of competition from the market in recent years. Christie & Co has recently predicted that a further 2,500 pubs need to close before the sector can be competitive again. Household budgetary constraints will continue to have a negative impact on the sector, as it will for the leisure industry as a whole.
According to a recent survey by the Association of Licensed Multiple Retailers, costs finally appear to be stabilising this year, although gross margins were still down by 6% against last year. If there are any further cost pressures (for example if the proposed plans for 'tax stamps' on all British bottled and canned beers is introduced) then the fallout from the sector could be significant.
Debt burden still high
Many operators will also be suffering from the cost of servicing debt taken on in the pre-2008 halcyon days of the industry. Lenders have of course been increasingly concerned by the falling loan-to-value ratios on those customers' borrowing against their real estate assets. However, over more recent years, lenders appear to have gained sufficient clarity regarding their exposure to actively manage their portfolio of distressed customers.
There is certainly evidence of this at both ends of the transactional market, with an increase in deal activity levels (albeit with a heavy persuasion toward cash buyers) and also in formal insolvencies (a number of which we have acted on). Furthermore, there is little evidence of significant lending being made available to small and medium-sized operators.
Smith & Williamson has recently been involved with a number of administrations and Law of Property Act receiverships of licensed premises (including nightclubs, restaurant and hotels). In most of these cases the businesses were trading for a period and sold as going concerns.
Sector trends
Looking within the sector, there are variations in market performance. Geographically, London and the Home Counties are performing better, benefiting in recent months by the weather wash-out, the Queen's diamond jubilee celebrations and Euro 2012. It will be interesting to see where the level of demand will settle after the world has gone home after the London Olympics. A more frequent and careful review of performance against budget by operators and their traders is advisable.
The types of operators who are stealing a march on the competition are those in the value pub market (but only those who have strong controls over their cost base) and the niche, food-led operators (at the expense of the casual dining restaurants). It is becoming increasingly more important for local management to differentiate their businesses from the competition. They need to be able to anticipate their customers' requirements, price their products appropriately and buy in the necessary resources (in particular food, drink and staff) in the appropriate quantities to be competitive. Those who can predict these and adjust quickly to changes in the market will be the survivors and indeed the winners.
Proactivity is crucial
Faced with this challenging environment, it is our experience that many operators have ignored the warning signs of falling trade and diminishing profitability, disregarded mounting creditors and not kept lenders informed of potential cash crises. In short, under-performance can often be down to weak management, e.g. poor marketing, lack of controls and a failure to assess and react to changes in the market quickly.
Too many proprietors do not produce timely monthly profit and loss accounts. Starved of management information and, consequently, with no way of obtaining and reacting to key performance indicators, businesses predictably start to slide. In turn, when a client defaults on a loan or its lender has problems obtaining the information it needs to help it assess the extent of the client's problems, a loss of confidence can ensue.
Lack of management/trading information can be a significant barrier to a sale of a business in the sector, regardless of whether that sale is by management or through an insolvency process. In our experience, value will not hold up unless proper trading information can be provided to prospective purchasers. Lenders should ensure that all of their customers are producing relevant and reliable management information, especially where an exit strategy is likely in the short or medium term.
Independent business reviews (IBRs) provide an opportunity to assist operators improve their business, set it on a firmer footing and rebuild its relationship with its lender. Where it is concluded that management does not have the capability and/or the confidence of its lender, then assistance can be provided by Smith & Williamson, often alongside specialist interim pub operator companies, to improve performance as part of a turnaround/exit strategy.
With strong management manning the (beer) pumps, looking at the fundamentals of the business, producing meaningful accounts that can be used to monitor key performance indicators, implementing financial controls, focusing marketing efforts and embracing the process and the recommendations of an IBR, it is often possible for operators to work their way out of trouble.
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