Is Stonegate in financial trouble?
By Michael Erridge
It’s been nearly 3 years since Stonegate completed it’s takeover of the UK’s then largest pub operator Ei Group in March 2020. To say the timing was unfortunate is probably the understatement of the century, given that the country was locked down literally weeks later to prevent the spread of coronavirus.
The £3bn deal was originally penned in July 2019 when the world looked a very different place, and the trading environment was vastly more favourable than today. Stonegate had won a plethora of industry awards and already completed several successful acquisitions, so acquiring Ei Group would be the ultimate pinnacle and make Stonegate by far the largest pub operator. The plan was to re-evaluate the portfolio and convert sites to more optimal trading models and thereby boost profitability.
What could possibly go wrong? Well, with hindsight, pretty much everything.
Without wishing to state the bleeding obvious, the problems began when Stonegate was forced to shutter it’s entire business. All of a sudden having the largest estate became a logistical nightmare and I can only imagine how difficult this would have been to manage. The industry was plunged into a crisis that was unimaginable just weeks earlier.
The knock on effect was that Stonegate was now viewed by the markets as extremely high risk, as hospitality was hit particularly hard by the pandemic with many fearing the worse. Stocks were in free fall, and those linked to hospitality were being decimated. Stonegate had effectively just lost it’s entire turnover overnight, but still had a large debt pile to service. This forced Stonegate to turn to the markets for finance at a very unfortunate time.
According to the rating agency Fitch, Stonegate’s Long-Term Issuer Default Rating (IDR) was rated as ‘B-‘ with a negative outlook. In simple language this means that their debt is considered ‘highly speculative’ with a ‘degrading financial situation’. As the debt is rated as non-investment grade, raising credit on the corporate markets is very, very expensive. The rating remains unchanged as of January 2023. (https://www.fitchratings.com/entity/stonegate-pub-company-limited-94041690)
In July 2020 Stonegate sold £1.2bn of bonds which consisted of five-year sterling and euro tranches worth £950m and €279m respectively. At the time this marked one of the biggest sterling-denominated “junk” bond deals ever seen. Incredibly the Sterling bond (maturing in 2025) offered investors a coupon (the annual interest rate) of 8.25%.
8.25% interest on over a billion pounds… just let that sink in for a minute. The Bank of England’s base rate was still below 1%, and the average mortgage rate for a 5-year fixed term was 1.69% (it seems a long time ago now!). I remember at the time thinking the FT had made a printing error.
For the full year to September 2020 Stonegate went on to report a loss before tax of £746m, with external debt totaling a whopping £2.97bn. Much of the loss was put down to the depreciation on its estate and financing costs from the Ei Group acquisition.
The lockdowns obviously had an enormous impact at the time, but there have also been longer term knock on effects. People’s habits have changed since, most notably in terms of working from home. As I write this now the train drivers are on strike again and working from home became normalised during the pandemic. This left Stonegate particularly vulnerable given their high percentage of city centre sites such as the cocktail chain Be At One which were important drivers for earlier profitability.
Fast forward to 2023 and the industry is now faced with an energy crisis, staff shortages, high inflation, general strikes and a cash squeezed consumer. Many pub operators still have no idea what energy costs will be beyond March.
It should therefore come as no surprise that Stonegate just announced the sale of 1,000 pubs in an effort to raise an estimated £800m. It was only a matter of time, and the writing was on the wall for the large pub group back when it borrowed such vast sums of money at eye watering and frankly, unsustainable interest rates.
On top of this, the Ei Group estate has changed a lot since the deal was agreed. At the time the estate was valued based on the Fairly Maintainable Trade (FMT, or profitability) of the pubs using relevant 8% to 12% multiples. These multiples were based on the profitability each site generated, many of which were tied pubs.
Since the valuation was undertaken, a number of these sites will have converted to MRO free of tie agreements. This can massively impact the site’s profitability. I should know, as I’ve dealt a number of such cases personally. The impact on a site can often be around a 50% reduction in income for a busy wet site.
In most cases overall trade has declined, and many sites that stayed tied will have agreed lower rents or frankly will be struggling to survive.
Then there is the pseudo managed Craft Union estate which is also facing huge cost pressures. Stonegate picks up the utility bills in return for paying a percentage of turnover. When the percentages were worked out energy costs were considerably lower, so now this model is also far less profitable.
As it’s clear to see there are pressures on all fronts, meaning there is no miracle recovery on the horizon.
So in conclusion it’s now fairly inevitable that Stonegate will be broken up over time and sold off to the highest bidder. The plan to acquire Ei Group was certainly bold and ambitious, and without Covid it’s fair to say that things could have turned out very differently. However, the writing has been on the wall ever since and recent events have only served to add fuel to the fire.
What this will all mean for Stonegate’s many tenants remains to be seen.
__
Have a tied pub with Stonegate?
If you are due a rent review or haven’t had a review in over 5 years, it could be an opportunity to consider going free of tie.
For more information visit www.mdepc.co.uk
