Fitch Affirms Mitchells & Butlers Notes; Neg Outlook on B, C, D
The affirmation of the class A and AB notes reflects strong free cash flow (FCF) DSCR ratios with significant cushion (supporting the Stable Outlook), at 3.0x and 2.4x, respectively, relative to Fitch's indicative 'A' rating guidance for whole business securitisation transactions of >1.95x.
The notes are constrained from moving above an 'A+' rating by Fitch's overall midrange industry profile assessment for the pub sector.
The Negative Outlook on the class B, C and D notes is driven primarily by forecast cost increases as a result of the National Living Wage target announced in July 2015, which is expected to put pressure on M&B's profitability as wages make up about 30% of total opex. Ongoing low revenue growth is also a contributing factor.
Mitchells & Butlers Finance is a whole business securitisation of a portfolio of 1,424 managed pubs and pub restaurants in Britain owned and operated by Mitchells & Butlers Plc (representing 80% of the M&B plc's pubs).
KEY RATING DRIVERS
Industry Profile: Midrange
Fitch views the operating environment as 'weaker'. While the pub sector in the UK has a long history, trading performance for some assets has shown significant weakness in the past. The sector is highly exposed to discretionary spending, strong competition (including from the off-trade), and other macro factors such as minimum wages, rising utility costs and potential changes in regulation. Licencing laws and regulations are moderately stringent, and managed pubs are fairly capital-intensive. Switching costs are generally viewed as low, even though there may be some captive market effects. The strong pub culture in the UK is expected to persist, thereby taking a large portion of the eating and drinking out market. In relation to demographics, mild forecast population growth in the UK is a credit positive.
Sub-Key Rating Drivers: Operating Environment: Weaker, Barriers to Entry: Midrange, Sustainability: Midrange.
Company Profile: Stronger
Like-for-like sales have an 11-year compound annual growth rate of 2.6%. M&B has never had declines in sales during this period, which compares favourably with Fitch-rated peers. Growth has slowed in recent years, with like-for-like sales growth in FY14 of 0.6%. M&B Plc's pension deficit was re-valued higher in 2013 to GBP572m, which Fitch views as a credit negative. M&B is a large operator of restaurants, pubs and bars in the UK, including a good range of strong brands aimed at both the more expensive and value end of the market.
The securitised portfolio includes 1,424 outlets, with reasonable geographical spread. Around 40% of the portfolio is located in the better performing London and South East England. As the estate is fully managed, there is insight into underlying profitability. Operator replacement is not viewed as straightforward but should be possible within a reasonable period of time. The pubs are considered to be well-maintained and feature a high minimum maintenance covenant. Further to this, M&B has shown a history of maintenance capex in excess of the required level. Maintenance spend over FY14 was GBP144.9m compared with a minimum requirement of GBP91.8m. Assets are almost all freehold.
Sub-KRDs: Financial Performance: Midrange, Company Operations: Stronger, Transparency: Stronger, Dependence on Operator: Midrange, Asset Quality: Stronger
Debt Structure: Class A - Stronger, Class AB, B, C and D - Midrange
The debt is fully amortising but there is some concurrent amortisation with junior tranches. The notes are a combination of fixed rate and fully hedged floating rate debt, and a currency swap removes FX risk on the US dollar-denominated A3N notes. The security package is strong, with comprehensive first ranking fixed and floating charges over borrower assets. Class A is the senior ranking controlling creditor, with the junior notes lower ranking, resulting in a 'Midrange' assessment. There is a minimum maintenance requirement of the greater of 5.7% of turnover and GBP35,000 per pub (indexed) annually, which compares favourably with peers. The securitised estate also benefits from a liquidity facility covering 18 months debt service, tranched at the class C and D levels. Other structural features include both debt service covenants and restricted payment conditions, tested quarterly.
Sub-Key Rating Drivers: Debt Profile: 'Stronger' for the class A notes and 'Midrange' for the class AB, B, C and D notes, Security Package: 'Stronger' for the class A notes and 'Midrange' for the class AB, B, C and D notes, Structural Features: 'Stronger' for all notes.
Peer Group
M&B is considered to be well aligned with its peers in the pubs sector. FCF DSCR and EBITDA leverage metrics are marginally lower than some of its peers with the same rating. This takes into account M&B's more reactive and transparent business model as a result of being the only fully managed estate among Fitch-rated peers.
RATING SENSITIVITIES
Positive - The class A and AB notes are unlikely to be upgraded due to the overall Midrange industry profile assessment. A positive rating action is possible for the class B, C and D notes should Fitch's base case FCF DSCRs improve as a result of sustainable sales growth or wage cost pressures being mitigated more effectively than expected when combined with further deleveraging over the next few years.
Negative - Any further decline in Fitch's base case FCF DSCRs due to underperformance against expectations (for example as a result of falling food volume growth and additional pricing pressure, as well as wage pressures) could lead to downgrades of the class B, C and D notes. The class AB notes are also at risk of negative rating action, but a greater margin of safety remains.
TRANSACTION PERFORMANCE
EBITDA in the year to April 2015 declined by around 2% to GBP358m, partly driven by a 0.6% reduction in securitised group pubs by number (based on annual average figures). This figure was also 0.3% below the previous Fitch base case. This resulted in EBITDA per pub of GBP250,900 which equated to a yoy decline of 1.6%, and represented a 0.2% negative variance to the Fitch base case. Full year FCF to April 2015 was reported at GBP285.9m (1.4% decline vs. previous year figure of GBP290.0m), which resulted in 52 week EBITDA and FCF DSCRs of 1.9x and 1.5x, respectively. Coverage has remained fairly stable since 2011, albeit with a slight deterioration in 2014. FCF under the Fitch base case is projected to grow by a CAGR of 0.1% However, this is not representative of the entire projection period, with projected FCF actually declining by 0.6% on average over the first 10 years of the projection period. This is due to our lower performance expectations compared to the prior year's base case as a result of the increased cost pressures due to the new National Living Wage target (GBP9 by 2020 for those aged 25 and over) announced in July 2015.
In relation to the class A and AB notes, their base case FCF DSCRs at 3.01x and 2.40x still place them comfortably at the A+ rating cap level, which supports the Stable Outlook. The base case FCF DSCRs (minimum of the average and median DSCR) for the most junior tranches B, C and D have again slightly decreased since the last annual review primarily as a result of the revised assumptions. The base case FCF DSCRs currently stand at 1.60x (down from 1.68x), 1.48x (1.54x) and 1.43x (1.50x) respectively, with the minimums at 1.49x, 1.37x and 1.33x. While the coverage decline supports a Negative Outlook, we do not view it as sufficient grounds for a downgrade of the junior classes given the strong nature of M&B's operations and low and decreasing leverage relative to peers (eg. Marston's and Greene King). However, the impact of the increase in the National Living Wage needs to be monitored. If M&B is not successful at mitigating the increase to some extent, the junior class B, C and D notes could be downgraded at the next review.
In terms of leverage, net debt to EBITDA remains relatively low compared to peers and is broadly in line with previous year at 2.25x (from 2.27x), 3.16x (3.16x), 4.59x (4.62x), 5.29x (5.31x) and 5.59x (5.61x) through the class A, AB, B, C and D notes, respectively. The leverage profile is also expected to improve as amortisation continues with net debt to EBITDA falling to around 5.44x in April 2016 through the D notes.
The rating actions are as follows:
Class A1N floating-rate notes (GBP165.3m) due 2030: affirmed at 'A+'; Outlook Stable
Class A2 fixed-rate notes (GBP300.8m) due 2030: affirmed at 'A+'; Outlook Stable
Class A3N floating-rate notes (USD346.2m) due 2030: affirmed at 'A+'; Outlook Stable
Class A4 floating-rate notes (GBP170m) due 2030: affirmed at 'A+'; Outlook Stable
Class AB floating-rate notes (GBP325m) due 2033: affirmed at 'A+'; Outlook Stable
Class B1 fixed-rate notes (GBP163.3m) due 2025: affirmed at 'BBB+'; placed on Negative Outlook from Stable
Class B2 fixed-rate notes (GBP350m) due 2030: affirmed at 'BBB+'; placed on Negative Outlook from Stable
Class C1 fixed-rate notes (GBP200m) due 2032: affirmed at 'BBB'; placed on Negative Outlook from Stable
Class C2 floating-rate notes (GBP50m) due 2034: affirmed at 'BBB'; placed on Negative Outlook from Stable
Class D1 floating-rate notes (GBP110m) due 2036: affirmed at 'BBB-'; placed on Negative Outlook from Stable.
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