Smokers aren’t the only ones who have been left out in the cold since the smoking ban was introduced last year. British pubs have had a torrid time of it too. The ban hasn’t helped, but hard-pressed consumers have also been shunning nights out in favour of cheap supermarket beer, while the Government has clamped down on drink-driving in rural areas.
However, last week’s news that HM Revenue & Customs had given pub group Enterprise Inns the green light to convert its business into a property trust – a move that could slash its tax bills – has lifted the gloom in the sector. Enterprise’s stock leapt 30% on the news and other pub stocks followed. A number of analysts even heralded a dramatic revival in the pub trade.
But be very careful here. While it is certainly true that it makes good sense for pub operators sitting on a lot of property to switch to real estate investment trust (Reit) status, it is no miracle cure for a sector that is in serious trouble. When a firm converts to a Reit it becomes exempt from all corporate taxes, provided that 90% of the income is paid out to shareholders via dividends.
Enterprise’s conversion, for example, will lead to a one-off tax benefit of £114m and £65m per year afterwards. This would allow it to double dividend payments in return for a one-off entry fee equivalent to 2% of the group’s asset value – about £120m. By switching to Reit status, says Dan Thomas in the FT, Enterprise is effectively avoiding a lot of tax without going to much effort.
No surprise, then, that analysts expect other publicans to follow suit. As long as an arm of your business derives at least 75% of its income from property rents – Enterprise Inns is effectively a landlord to its publican tenants – it can be spun off as a Reit. Other candidates include Punch Taverns, which, like Enterprise Inns, has bought pubs in bulk over the last decade. In fact, the two pub groups are now Britain’s biggest landlords.
In recent years, however, they’ve been losing potential tenants fast. British pubs are closing at a rate of four a day – 14 times faster than in 2005. There are just over 57,000 pubs in Britain today, compared with 69,000 in 1980. Chris Unwin, who owns four pubs in Plymouth, told The Times that he had been forced to inject £250,000 in the business to keep it going after last summer’s bad weather and rising costs. Rates at one of his outlets had shot up from £13,000 to £21,000 in a year.
The Government hasn’t helped, repeatedly slapping duties on the price of a pint, happy in the assumption that punters would never change their drinking habits. But they have. Thirty years ago, as much as 95% of beer was consumed in the local pub. Last month, pubs accounted for less than half the beer consumed in Britain. With the price of a pint rising (UK beer is the highest taxed in Europe) we’re staying in on Friday nights, picking up cheap wine and beer at the supermarket and watching a film. Beer sales in pubs haven’t been this low since the depression of the 1930s.
So while pubs are now trading at historic lows, note analysts at JP Morgan, they are by no means cheap. And a grim economic outlook means they could go lower. This is the first time the major pub-landlord groups have traded through a heavy consumer downturn, notes Matthew Goodman in The Times, and no amount of gourmet burgers or tax breaks will improve business this year or next. For pub owners in quieter backwaters, the best option open to them might be to sell their property and get out.
Which other firms might go down the Reit route?
After Enterprise Inn’s announcement last week, many expected a rash of firms to start their own application for Reit status. But while the move makes sense for Enterprise, says Kate Pettem of Landsbanki, other pubs have been reducing their tax burden by re-investing profits back into the business. Their tax savings would not be as impressive as Enterprise’s, which has a relatively large tax burden.
The best candidate, according to analysts at JP Morgan, is Punch Taverns (PUB), which by spinning off its tenanted business, could save 200p per share. On a forward p/e of 7.5, JP Morgan has a target price of 900p for the stock.
The only other likely candidate for Reit status is the hotels sector, says Brewin Dolphin analyst David Pope. Retailers such as supermarkets simply don’t have the correct property profile to qualify. But for conversions to be viable, Reits need to be in demand, says Pope. That’s anything but the case just now – UK-based Reits may well be an attractive investment at some point in the future, but with the property market in the state it’s in, investors are shunning the sector. That means hotel groups are unlikely to embark on a process that could take them a year to complete, tax savings or not.