Don't Stand So Close to Me: UK Distancing Rules Could Create Acquisition Opportunities for Brewers
As lockdown prevented people from visiting pubs and restaurants across the globe, revenues for the on-premise sector dried up. In many countries, government support has provided a lifeline, but the industry is by no means out of the woods. Opening up is providing many challenges. In the UK, where structural changes were already taking place ahead of the outbreak, further headwinds are likely to result in forward integration by brewers keen to maintain a route to market in the on-premise trade. Where legally allowed, we expect other countries to follow suit.
Although the pub is identified across the world as a typical British institution, the sector has had a difficult time. Between 2002 and 2018, the number of UK pubs fell by more than a quarter. In 2019 however, numbers increased slightly and it looked like the sector might finally have turned a corner. The Covid-19 crisis and the government announcement on March 20, 2020 to temporarily close all UK on-premise establishments temporarily set the nascent recovery in reverse.
UK Pubs Have Weathered the Covid-19 Storm Well, but Financial Position Has Weakened
During lockdown, almost all UK pub revenues disappeared, but we estimate that they have also been able to ‘save’ around 90% of their operating expenses. The government introduced a furlough scheme (basically taking over payment of salary to employees) and suspended property tax for a year. When locked down, pubs did not run up utility bills, but some fixed costs like insurance and professional fees continued. The largest costs for pubs during lockdown would normally have been rent (for managed pubs) or mortgage interest (for freeholds), but many pubco’s, brewers and banks agreed to give postponement or relief. Without relief, we estimate that the average pub made a loss of GBP 5,000-GBP 20,000 during the 11-week lockdown period. For smaller pub owners, a grant provided by the government has given further support, but obviously this did not fully compensate for missed profits. Overall, however, the impact of lockdown has been manageable and most UK pubs have so far been able to survive.
Opening-Up Provides Big Challenges
On July 4, pubs in the UK reopened under strict distancing rules. Although this is welcome news, landlords are encountering a very difficult operating environment. With distancing rules set at the WHO’s proposed three feet, visitor numbers are likely to be 30% below pre-Covid levels, while costs are expected to increase. Some cost items are incidental, such as the disposal of stale inventory and the installation of safety equipment for visitors and staff (like payment apps and face shields). Other costs will be recurring. Weatherspoon has announced they will employ two extra people per pub to deal with issues such as cleaning surfaces and keeping visitors at the right distance. On a pro-forma basis, pubs are expected to lose on average GBP 15,000-GBP 55,000 over the next twelve months (see Table 1) unless distancing rules are relaxed further or other measures, such as outdoor seating, price rises or service-level reductions are taken.
Structural Changes and Covid-19 Will Change Landscape
It is important to note that the P&L estimates above assume that the consumer will behave similarly to how they behaved pre-Covid-19, but we know this is not the case – the pandemic is expected to create meaningful changes in the structure of demand. Countryside pubs are generally relying on traffic from ‘the grey pound’, but older customers are more susceptible to the virus and might be less keen to return to the on-premise trade. Inner city pubs, meanwhile, often rely on commuters who will now work from home more often. Both types of pub might recognize the need to refurbish to cater for the ‘new normal’, but for many independent landlords this will prove difficult, due to their precarious economic situation.
Not every pub will struggle while distancing is in place. Some pubs will cope better with the new situation and outperform the abovementioned averages. There are also landlords that have built up large enough reserves in previous years, to enable them to weather the storm. However, the BBPA expects that 40% of British pubs could go broke by the end of the year if trade disappoints, for example due to poor weather conditions or further temporary closures. For some landlords of independent pubs, these conditions and uncertainties could be reasons to look for alternatives.
In today’s low interest rate environment, pubs are an attractive long-term investment. In 2019, Greene King achieved an ROA of 10.1% on its pub estate, roughly double the cost of capital. The company was subsequently bought by an overseas investor. If asset values come down in the wake of the current crisis, long-term valuations would become even more attractive for cash rich pubco’s and brewers. For the latter group, buying pub assets is also a defensive move. As the beer brand landscape fragments and consumers drink ‘less but better’, brewers rely on the on-premise trade to create profitable new aspirational brands. In the late 1980s, brewers in the UK owned over half of the pubs, but were forced to sell off most of their estate (see Figure 1). Regulations have since relaxed and the share of brewers has been creeping up in recent years. The aftermath of the Covid-crisis is likely to see an acceleration of this development.
Where to go from here
Francois SonnevilleSenior Analyst - Beverages Read more