Punch Taverns — improving operator, share price yet to catch up

Stagnant share price despite investment and debt reduction:

• Today, Punch’s shares languish on a lowly PE ratio of 5.7 (106p). They have been on as little as 4.8 times earnings (89p) this year, and have fallen by 15% since the start of 2016 (Jan ’16: 125p).
• Yet this lacklustre performance belies the busy activity of a pub company that is not only diligently paying down debt but actively driving innovation across its estate of c3,500 pubs.
• We believe yesterday’s announcement (re. paying down £65m of its Class B4 notes) confirms our view that the market is materially mispricing Punch Tavern’s shares.

The market does not believe Punch has changed, but the accounts show otherwise…

• On 26 October, 2014, Punch shares were selling for 150p despite the group having £1.6bn of gross debt post-restructuring. Today’s share price is at a notable c30% discount of 106p.
• And yet Punch has come a long way operationally, strategically, and financially since then.
• FY15 accounts show borrowings of £1.511bn. When the c£225m of debt reduction referred to in the group’s FY16 Trading Update is factored in, alongside today’s B4 Notes announcement, this figure falls to c£1.220bn.
• Although this level of debt is still very high (c6.6x EBITDA), Punch has a large freehold estate, and its debt reduction rate of c19% in just over a year is material.
•      The market either doesn’t know about Punch Tavern’s progress, or it doesn’t care – and therein lies opportunity.

Less debt –> more cash –> more investment –> positive LfLs –> re-rating

• Punch’s share price does not reflect the latent upside in its changing capital profile.
• Debt has been slashed by 63% since 2010, when the group was routinely referred to as a ‘zombie co’, and has fallen by 46% in the two years since its financial restructuring in 2014.
• Meanwhile the group has stable operating cash flows and like-for-like sales have been consistently growing since the first half of FY14.
• Punch’s shares trade on a modest PE ratio of 5.7 times and a material discount to book value and yet the group is reducing debt and growing LfLs. A re-rating of the shares is arguably deserved.