I wonder whether the City has been spending a little too much time frequenting this company’s bars – I can’t think of any other reason why the its share price should have gone up recently. Admittedly, bars have benefited from the recent football World Cup, but for a pub group – albeit one that is very well run – to be trading on p/e ratios of 15 and 14 respectively for this year and next seems rather too expensive. Particularly as the board believes that the pubs’ future growth in core operating profits will only be around 3% a year – which will hardly be a stellar showing.
Turkey of the week: Enterprise Inns (ETI, 1,034p), tipped as a BUY by JP Morgan and Investors Chronicle
My suspicion is that fund managers have become overly excited about the potential returns on offer if Enterprise Inns either converts into a real estate investment trust (REIT), or is acquired by a private equity house.
A takeover is always possible, although I believe the likelihood is low, because Enterprise Inns is already saddled with £3.1bn of debt and interest cover of only 2.5 times. Thus there appears limited scope to gear up the balance sheet further with more cheap debt. The option of converting the property portfolio into a REIT does look interesting, because it should then escape any capital gains tax on future asset disposals.
There are several reasons why I think that Enterprise Inns’ shares are overvalued. Firstly – and probably most importantly – by this time next year, smoking will be banned in all public places across the UK. These restrictions have already been implemented in Scotland and pub profits have been hit. This, coupled with a weakening overall consumer environment, will provide a strong headwind against
future revenue growth.
Secondly, running costs – such as wages, rates and utilities – are all rising (at around 8% in total), which is squeezing profit margins. Some of this expense will be recovered through higher bar prices and overhead savings. However, this will further widen the gap versus the take-home market. Finally, earnings per share comparisons will become that much harder next year, because there is no major football tournament.
All in all, I would value Enterprise Inns on a sum-of-its-parts basis, assuming that it converted into a REIT. The market value of its freehold properties is approximately £4.9bn, with the pub business, on a stand-alone basis, worth another £1.3bn. After subtracting debt of £3.1bn, and assuming no tax leakage due to the REIT structure, I believe the fair value for the company’s shares is around 940p – or approximately 10% below today’s level.
In my opinion, Enterprise Inns is a play on the continuing health of the UK property market, and I think there is better value to be had elsewhere.
Recommendation: TAKE PROFITS at 1,034p
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