Stonegate - Raise A Glass to Extra Time - Model Updade - Positioning
All,
Please find our updated analysis here.
Stonegate has been looking precarious at times, never mind the asset backing. The Run Rate Adjusted EBITDA calculations have been dubious from the start and continue to exclude every negative trend that the company already knows well about. Still, the momentum is now with pub companies and the Platinum transaction should provide enough liquidity to refinance in one way or another. So, buying a name at par that might refinance within a year and that still struggles to pay for its interest is unusual to say the least, but we don’t think we will be losing money here and the near 11% coupon pays for it.
Investment Considerations
• We are taking a 5% of NAV position at par in the Stonegate 10.75% 2029s with a view to benefiting from a deleveraging of the estate via a partial sale of the Platinum estate. The cash flow performance is not yet what the market will require to refinance these bonds, but we consider a refinancing open on a deleveraged estate with positive momentum.
• A running yield = YTM = coupon of 10.75% at par is better than cash, and we have cash lying around. Meanwhile, we consider the fundamental downside to be very limited now, perhaps three points for a disastrous quarter, which we don't think will be coming. On the upside, if at all, we could imagine a slight cash premium to incentivise us to give the company more time to grow into this capital structure from its diminished position.
Key Conclusions
• An orderly refinancing/redemption of the bonds now seems to hinge on a profitable sale of at least part of the Platinum portfolio in FY26. Otherwise, liquidity should start to wear thin. A partial sale, however, should suffice to reduce leverage in the vehicle enough to either get a new local refinancing underway, or more likely, allow a global refinancing with the help of some cash component that would bring the Platinum estate back into the restricted group (Model).
• Rent rises and premiumisation continue to stick. We consider those high-quality revenues that return Stonegate's revenue profile to that of other more ordinary pub groups: contracted, low-elasticity inflation-linked income (Current Trading).
• Since Q325, the company surprised us with lower-than-expected expenses. In part, that is technical, because the conversion of large swathes of its managed estate into operator-led venues has meant that the same pubs fall under a different accounting treatment. Still, earnings are higher than expected on broadly accurate revenue projections, narrowing the negative LCF the company has been producing. (Current Trading, Model).
• DCF remains very elevated relative to earnings. Cash translation of EBITDA is very good and the earnings quality is high - hence the high EV and EBITDA multiple. But EBITDA is low to start with and the company does not own all its real estate. So, despite its stabilisation and positive momentum, normalised earnings do not yet pay for the interest bill and EV is a mere 70-75% of debt.
• Managed gastro pubs and bars and venues like Slug & Lettuce, once the primary revenue drivers, have been heavily exposed to wage and tax rises. Stonegate has largely dismantled the entire division to focus on more traditional L&T-type O-Lead economics. Of the managed estate, Stonegate appears to be holding on only to a subsegment of gastro pubs and is seeking to reposition chains such as Slug & Lettuce (Company).
• Aggressive run-rate EBITDA add-backs overstate profitability, with many one-sided adjustments and a two-year lag before executed measures flow into actual EBITDA. Long after the early '24 plan claimed it would bear fruit, the first signs of cost improvement have finally shown through. But that does not fill us with confidence that we will see the rest coming as advertised. (Cost Savings '25).
Q226
• Revenue ran modestly below our forecast while margins continue to grow. Turnover of £335m came in c.£19m light of our £354m forecast, the shortfall concentrated in Drink (£259m vs £277m) and Food (£21m vs £30m) as managed sites convert out; Rent held at £32m, ahead of our £30m.
• L&T carried the group and the growth is in rent, not volume, which is what makes it durable. Site profit grew +7.8% to £59m on +1.9% LFL, with volumes down -3% to -4% and rent up +5% (CPI plus uplifts on capital schemes). That begins to return the P&L to contracted, inflation-linked income with low cost sensitivity (original pub group economics).
• Operator-Led delivered +15.1% site profit on +3.2% LFL. We now consider the range interventions sticky rather than a bounce. Growth came from premiumisation (Guinness, Madri) among value-led consumers on volume of -2%, not list-price rises.
• Cost control continues well above our expectations only last year and together with the reshaping of the portfolio marks a delayed byt now pronounced turnaround in economics. CapEx and other CF items were in line.
• The business is almost breaking even, losing about £10m per quarter after interest, and the improvements are not sufficient to avoid having to sell the Platinum estate, or at least large parts of it. The process remains underway, and we expect news in Q426. However, we no longer expect Stonegate to sell more than 1/3 of the estate. The company should be able to use the proceeds to refinance the remainder of the estate on a more sustainable / less expensive basis and play for time, as bond and financing maturities only come in early 2029.
• As if to keep cash above £100m, management drew the RCF again to £168m (interest-paying quarter).
• Liquidity of c.£131m is thinner than Q1's £225m, and the Platinum outcome now matters more.
Looking forward to discussing this name with you,
Wolfgang
T: +44 203 744 7003
www.sarria.co.uk