MARS Attacks!

A pint of Hobgoblin and a half of Black Wych

A Very Happy New Year to you. If you spent it in a pub then my first blog of the year should bring the convivial atmosphere and smell of real ale back to you because it’s about Marston’s (MARS).

As you can see from the chart, the shares are looking a lot cheaper than a pint of beer these days. You can buy them for about the same price as they cost throughout the nineties.

Marston’s is mostly a pub operator, deriving income from selling its tenants and licensees drinks, charging them rent, and taking a cut from gaming machines, although it manages about 500 pubs itself.

About 16% of revenues come from brewing. Amongst its famous brews are the premium Marston’s Pedigree, and the more prosaic Banks’s.

It’s been a tough year in the pub business, with sales and margins down slightly as customers have stayed home more, and spent less when they’ve ventured out. Marston’s earnings per share have declined rather more, about 28%, largely because it issued more shares in a rights issue.

In its recent annual report, chairman David Thompson said the company benefitted from the increasing popularity of dining out and real ale, which it has enshrined in it’s ‘F-Plan’. ‘F’ stands for a focus on food, families, females and ‘forty/fifty somethings’ and not, apparently, Ralph Findlay, the chief executive that has championed the strategy.

The company looks quite strong. It’s profitable in accounting terms, and more so in cash terms, debt came down (albeit by a small fraction) and the only concern about its operating performance is what looks like a temporary decline in profitability.

Generally a rights issue is a sign of weakness, though, implying a company cannot finance itself from its own resources, or convince bankers to lend it the money it needs on terms it likes. Statistically shares in companies that raise money this way tend to do badly relative to other companies.

But MARS is on the attack. Seemingly, it doesn’t need more cash to survive, but it plans to spend £140m of the £166m it raised accelerating its plan to build sixty new family-friendly pubs over the next three years.

By taking advantage of recession in the property and construction sectors it expects to find new sites more easily and build new pubs more cheaply enabling it to earn a higher return.

Such contrarianism appeals to me, I must admit, which is why I’m prepared to consider Marston’s, despite its enormous debts. Marston’s has over a £1bn in debt, most of it secured against its pubs.

Its total liabilities, which include other liabilities like the deficit on its pension scheme, are 68% of its total assets. In other words it owes more than half of what it owns.

It can justify such high levels of borrowing because its profits are so so consistent it should never default on the interest. According to Sharescope, Marston’s worst result since 1992 was earnings of just under 7p per share in 1993, which compares to just under 13p in 2009 and about 19p in its best year 2007.

Meanwhile, by putting its pubs up as security, Marston’s  reduces the cost of the borrowing and the company will not have to refinance the securitised portion of its debt for decades.

The chart below shows the percentage change in Marston’s earnings per share, and the percentage change in its ratio of shareholders’ equity to total assets, measured since 2000:

The ratio of equity to assets has declined, reflecting, in part, increased indebtedness through two rounds of securitisation in 2005 and 2007. By way of explanation, the basic balance sheet equation is:

total assets = total liabilities + shareholders’ equity

So, if the contribution from shareholders’ equity (essentially profit retained by the company) has fallen as a proportion of total assets then liabilities have increased and the company is more reliant for funding on money it owes than on money it’s earned than it was before.

Profits have risen too, although not as much as the share price, which demonstrates that investors were carried away earlier this decade imagining what Marston’s might do with all the cheap money it was borrowing.

Now the share price has crashed back down to earth, I’m wondering if the reward, its ten year price earnings ratio is just six which makes the shares look very cheap, justifies the risk of buying shares in such a highly indebted company.

The Chairman, who’s been with the company since 1977, bought well over 100,000 shares at about the current price in the summer, and the financial director, Andrew Andrea, made his first purchase of Marston’s shares since he was promoted to the job last year. He paid 89p, a penny more than an investor buying them today.

If it weren’t so indebted, Marston’s would be a screaming buy but the fear that must be haunting investors is a repeat of the situation at Punch Taverns, which is selling pubs to make its interest payments.

I find it difficult to believe an experienced board like Marston’s’ would be so bullish if that were likely, so I’m sorely tempted to add it to the Thrifty 30. But this is a decision I must sleep on. With earnings per share likely to fall next year because there are more shares in issue, and interest payments only covered twice-over, the market’s verdict, that Marston’s is deservedly cheap because it’s risky, might be the right one.

The trouble is, with the glazed look in Mr Findlay’s eye, and his jolly smile, I can’t make out whether he’s confident, or he celebrated a ‘resilient’ year with one pint of Jennings Cocker Hoop or Hobgoblin too many

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The death of the iPod

The Economist publishes a chart of the Nikkei and Japanese Govt Bonds that should put a chill up the spine of any stockpicker, this chilly day.

Service sector bosses are optimistic, manufacturers are pessimistic. But does that mean that the outlook for manufacturing is bad, or manufacturers are pessimists?

And the award for the best new way of saying “I haven’t got a clue” goes to a pharmaceutical manager who was heard to say: “I don’t have a good optic on that at the moment”. Lucy Kellaway presides over the 2009 Guff Awards.

Jonathan Davis says Sir John Templeton would be betting on the Dow reaching 16,000 by 2020.

Remember this when you read this year’s pundits: “Next Christmas the iPod will be dead, finished, gone, kaput” – Alan Sugar 2005