Today Marston’s (LSE: MARS) released a trading update covering the first quarter of its 2020 financial year. Investors reacted badly. Shares in Marston’s were down by as much as 10% but had recovered from the 105.4p low to around 108p at lunchtime.
Marston’s pubs had a merry Christmas, with sales up 4.5% year on year, but had a soft start to December because of bad weather. Overall first-quarter sales were 1% better on a year-over-year basis. Souring the tone was a statement indicating that the 6.2% rise in the national minimum wage, due in April, would increase costs in the second half of the year by £2–3m.
Concerning costs
Operating costs were noted as a concern back in November when the company reported a loss of £18m for the 2019 financial year. Operating expenses were 91% of revenue for 2019, compared with 88% in 2018, which does help to explain why 2018 ended with a profit of £45m, and 2019 did not.
Keeping a lid on staff costs will be even more difficult for Marston’s with the minimum wage rising. In 2019, head counts were reduced by around 250, at the cost of £2.3m, but Marston’s has been selling pubs to reduce its debt.
Selling off pubs to reduce debt, while continuing to buy new ones, must mean losing low-profit assets and replacing them with better ones. It will be interesting to see how this develops.
Investors got an update on the debt reduction plan today. The target is to reduce borrowings by £200m by 2023. The plan is ahead of schedule, with £60m in assets disposed of in the first quarter of 2020.
Investors have been grumbling for many years that Marston’s has too much debt. Borrowings have financed around 70% of the company’s assets since at least 2012. Put another way, the company has, on average, 2.4 times as much debt as equity.
I believe a coming change in the accounting treatment of leases has prompted Marstons to reduce its debt. The 2020 financial statement will include an extra £285–310m in borrowings from this change. Profits will also be £3–7m lower than they would have been once the change takes effect. The change will have no impact on cash flows.
Closing time
Investors have not taken kindly to the trading statement and appear to have priced in a 2020 loss. Although revenues have been growing each year, costs have been eating more and more of them away. Management thinks that the market will grow in 2020, as consumers are enjoying low unemployment and wage growth.
But it is costs, not revenues that have been the problem. Debt reduction will help bring financing costs down, but I cannot see a dedicated plan to reduce operational costs. Perhaps selling high-cost pubs and buying fewer, but more profitable, new ones will kill two birds with one stone.
If 2020 has fair weather, revenues will get a further boost (there is a good correlation between sun and income) but on balance 2020 looks to be more rain then shine for Marston’s.
The dividend yield is around 7% at the moment. I think there is an appreciable risk of seeing that fall in the future. Investors will run for the exits if dividends are cut.
If management can get a hold on costs, reduce debt, the economy holds up, and the sun shines, then this stock could do well. That’s a lot of “ifs”.
