Pubs have been a key part of the fabric of British life for hundreds of years. But pubs are not great businesses. Costs are high and profits are low. It is also relatively straightforward to set up a pub. The most challenging part is complying with licensing and planning conditions. Aside from these hurdles, there are few other barriers to entry for potential rivals. These challenges explain why the number of pubs across the country has been falling for decades.
But there are plenty of bright spots. People still want to go out, drink, eat and have a good time with friends and family, and demand remains high. As we saw in 2021 and 2022, as soon as the challenges of the pandemic were overcome, people wanted to go out again. It’s part of human nature, and that is unlikely to change.
The sector suffered between 2020 and 2023 when Covid disrupted trade and inflation surged following Russia’s invasion of Ukraine, forcing costs higher and eroding profit margins. However, these challenges are now starting to fade, while household spending, which didn’t decline as much as many analysts had predicted amid the mild recession last year, is beginning to accelerate.
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Fuller Smith & Turner (LON: FSTA) is one of my favourite picks in the hospitality sector. It recently reported a record year of trading and, in its latest update, reported like-for-like sales growth of 5.3% for the first 16 weeks of its financial year (to 31 March 2025). “With inflationary pressures easing, our margins are recovering,” it added.
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Peer Young & Co. (LON: YNGA)also recently reported bumper trading for fiscal 2024, and in the five weeks since the end of the year (to 1 April) has reported like-for-like sales growth of 3.4%, with this gauge rising to 10.6% during the first two weeks of summer.
Mitchells & Butlers (LON: MAB) has reported like-for-like sales growth of 5.7% for the 42 weeks to 20 July 2024. For comparison, the CGA RSM Hospitality Business Tracker reported 4.2% like-for-like sales growth in pubs across this period.
Should you invest in Marston's?
The other player in the sector, the company I want to cover today, is Marston’s (LSE: MARS). This is not usually the sort of business I would recommend. Indeed, six months ago I would have said investors should avoid it. Debt has been a weight around the company’s neck since the financial crisis.
It ended its 2023 financial year with net debt of £1.2 billion, 6.5 times more than its market capitalisation. That’s not the sort of position any company would want to find itself in heading into a higher interest rate environment. In its 2023 financial year, the company paid roughly £100 million of interest on earnings before interest and tax (EBIT) of £130 million.
However, at the beginning of July, Marston’s agreed to sell 40% of its joint brewing venture with Carlsberg for £206 million in cash. Management intends to use the proceeds of the sale to reduce debt and has estimated that it could save as much as £18 million a year in debt interest. On top of this, the company has also published robust trading figures, following its peer group. For the 42 weeks ended 20 July 2024, like-for-like sales grew by 5.2%. The company should also benefit from moderating cost inflation.
Marston's improving margins
The sale of the brewing business will affect the firm’s profitability over the next few years, but analysts believe that this will be more than offset by lower debt and interest costs, and sales growth as well as a recovery in margins. Analysts at Panmure Liberum foresee the company’s EBIT (operating) margin rising from 15.4% in fiscal 2023 to 15.8% in fiscal 2025 and then 16.3% in fiscal 2026.
Based on these projections, lower interest costs and continued debt reduction, analysts have pencilled in profit before tax of £81.4 million by fiscal 2026, up from £35.5 million in 2023. Lowering debt is a key focus of management.
In addition to the sale of the stake in the joint venture, the company has also indicated that it expects to sell around £50 million of property this year, with further significant disposals likely in the years ahead. There is plenty of flexibility in the balance sheet to facilitate this goal. At the end of fiscal 2023, the group reported debt of around £1.6 billion compared with property assets of £2.1 billion.
What's the outlook for the stock?
Marston’s isn’t an investment for the faint-hearted. It is a risky play, but it does have lots of upside potential if management does manage to execute its strategy successfully over the next couple of years. At current prices, the company is trading at a discount to book value of approximately 60% (book value is in the region of 100p per share).
In addition, the stock is trading at a forward price/earnings (p/e) multiple of six, below its pre-Covid average of 10. Averaged out, these numbers suggest that the stock has an upside of around 110%. As I have noted, this is far from a risk-free investment, but the potential upside of more than 100% over the next couple of years more than offsets the risk.
With sales expanding and the recent joint venture disposal, the company does not have to do much more for this scenario to play out as long as consumers’ spending remains robust and continues on its current trend. If inflation also continues to moderate and profit margins recover, Marston’s should benefit from the additional cash flow. Ultimately, as long as there are no unforeseen shocks, these trends should continue and allow Marston’s to return to a degree of stability over the next two years.
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