Marston’s (MARS)

Stronger and cheaper

Stronger and cheaper than what, I hear you ask? Well, Marston's were the second company I properly analysed - though I never did a writeup on them - and Philip O'Sullivan jogged my memory recently by suggesting I take another look at them. Firing back up my spreadsheets (which are, unsurprisingly, far neater than they are nowadays!) I saw only positive comparisons; they've been dragged down by the general market fall, over 10% since my first look, and they managed to meet the market expectations I had my doubts about in the first place. As you see from the graph and table, then, metrics look good. 2009 was a significant (but understandable) dip, apart from which they've earned good profits. The 5 year average sits at £58.5m, or a 5YP/E of under 10.

Those of us in Britain will probably know what Marston's do, but their business is split into three divisions - Inns and Taverns, Pubs, and Beer. The distinction between the first two is the managed vs. tenanted debate - Inns and Taverns are managed by Marston's themselves, whereas the Pubs division comprises those leased out. The pie chart below shows the split between these divisions. On gut feeling I quite like the business model as it is, as they proudly declare, vertically integrated. It benefits from its scale and expertise, and enjoys strong margins because of it.

A cursory glance at the chart and the gap between operating profit and net profit points to the obvious downside of the business, though - large interest payments implying a big debt burden. That's exactly the case, but I've become somewhat accustomed to it with my soiree into retail - after all, riddle me this: is there really such a fundamental difference between a retail company with long-term lease commitments (no property on balance sheet, no debt on balance sheet) or Marston's, who own their property and finance it with long-term loans (property on balance sheet, debt on balance sheet)? Both companies have similar cash outflows; rent or interest. Both companies, essentially, have absorbed the risk of being beholden to someone else - for that's exactly what onerous long-term commitments do; transfer cash flow risk to the leasee. From a debt and cashflow position, then, they look almost identical. The only difference as far as I see is who takes risks on the long-term value of the underlying property.

Still, my little soapbox moment aside, I'm not saying companies having a pile of debt is a good thing, or even that I want to invest in indebted companies; simply that I don't see much fundamental difference between this arrangement and a leased arrangment which would inflate RoE and other metrics. While Marston's do have a great deal of debt, though, the property ownership I've hinted at above is the other side of the coin - and the bar chart below shows the positive consequences of that. Marston's have a tangible book value of less than 1, meaning that the shares today buy you more than their worth in solid assets - if you trust the valuation of these solid assets!

Debt maturity and cash flow is particularly important when looking at a company which has such large commitments, but Marston's doesn't particularly worry on that front - around 80% of their debt has a maturity of over 5 years, and interest rates payable are low because of the assets on which they are secured. Interest is covered almost three times over by EBITDA.

From a consumer spending point of view, I think the future looks pretty good for Marston's. Pubs have, I think, been a bit slow to keep up with moving trends - and shifting their pubs from watering holes into more welcoming restaurants should continue to improve margins. As I often say, I think having maintained strong operating profits over the last few years bodes well for the future, though the near-term is certainly still very uncertain, with real wages still looking rather depressed.

Probably the most interesting facet of this case is the management commitment to further investment and capex. While cash flows could well be used to pay down some of the debt pile - Marston's generated £182.4m of net operating cash inflow, of which £103.3m went on interest and dividends - the management chose last year to rather slightly increase the debt levels of the group. £111.5m of investment was the root cause of that discrepancy, of which I found £45m on newbuild pub-restaurants and £23m on maintenance/improvements in the Inns and Taverns division, and £13m of maintenance against a total £33m in the Pub Company division. It appears a great deal of this spending is discretionary, then.

To be honest, I quite like that course of action. Unlike many other forms of consumer spending I've recently been looking at - clothes, electricals, food, there's something inherently different about going down to a pub or a restaurant. It is as much a service as a good; you pay for the atmosphere, the saving of effort in not having to cook, perhaps the nice setting the pub is in. I don't think there is any indication of a secular trend away from eating out, then; if anything, it's probably a growing sector. Since that's where the margins are - food rather than drink - I think the future looks bright. Marston's strong performance allays some of my fears about the whole tenanted lease arrangement, but I couldn't help but at least think about Punch Tavern's nightmarish fall. I don't think Marston's metrics are as bad as Punch's were, and (once again) I'd note that the current environment is a tough one - they have headroom in their banking facilities now, and consumer spending is at very low levels.

I like Marston's. I don't have space for it in my portfolio, but it's high up on the list if something pops and I sell. That said, I do need to do more research about the arrangement they have with their franchisees; I always find the situation rather awkward. Investing in a franchisor implies an investment in the franchisees, but we have little knowledge of whether they're scraping by or booming, and whether the franchise arrangement is sustainable or not.