Overview
It wasn’t just Covid that spelt disaster for many of the UK’s traditional local watering holes. The decline and fall of the English “boozer” has been well-documented and has continued at pace for years. Rising costs and a move toward healthier lifestyles and socialising elsewhere wiped out a business model rooted in lunchtime and after-work binge-drinking in which many Brits no longer indulge. More than 15,000 pubs have closed their doors in the past five years.
This sparked a national conversation, both mourning the loss of a neighbourhood amenity and quietly celebrating a health-conscious trend. But pub operators, which own large estates - sometimes of hundreds of bars across the country - are also adjusting, and some that have survived are healthier than before.
One thing the big corporate owners of UK public houses have going for them is that they are substantial landholders. Of the 2,500 sites owned by Greene King for example, over 80 per cent are freehold [1]- British legalese for owning the land you stand on - providing strong security for credit.
Moreover, even though the sector has been forced deeper into debt by the chaos visited on owners by the pandemic, the surge in consumer inflation since 2021 has allowed those left standing to push prices up sharply while the spike in energy prices that drove surges in costs last year has now dissipated.
Pub operators offer bond investors essentially two types of debt to invest in, with varying risk profiles, but both come with a catch.
Issuing high yield bonds became popular for the sector during Covid. However, in a higher interest rate environment coupled with upcoming maturities and lack of underlying asset security, these structures suffer from elevated refinancing risks.
In contrast, Whole-Business Securitisation structures (WBS), which dominated funding in the early 2000s, are secured on the real estate (the pubs themselves) and the revenues they generate, providing stable, predictable cash flows to service the debt. WBS therefore provide good sources of income and return, backed by land, for bond investors. The only catch is that they’re less liquid than straight corporate bonds.
Attractive credit features in investment grade pub WBS
Issuance of WBS has fallen over the years, with corporate treasurers preferring the greater flexibility high yield bonds give to issuers. This has left WBS as a much sought-after alternative. Operators’ expected cash flows typically exceed the debt repayments on WBS by a healthy margin. Bond holders also tend to be in a senior position in the capital stack, allowing for strong credit ratings on certain WBS transactions that can exceed the credit rating of the issuing company as a whole, or the assets in isolation. The combination of security and seniority can mean that even if the parent company goes into default, the WBS may not.
WBS structures also tend to come with issuer-friendly bond covenants. These are legally binding clauses embedded into bond documentation which set out certain activities that must be undertaken, or what activities are forbidden, by a bond issuer, helping to protect the interests of the lender.
Lastly, most pub WBS bonds tend to be amortizing, meaning principal is paid down during the life of the bond which helps to reduce “capital at risk” over time.
The income potential from these structures tends to exceed that of similarly rated corporate bonds. As chart 2 shows, the yield on Green King Triple-B is 7.5 per cent, exceeding the yield offered by sterling triple-B corporate bonds at 6.7 per cent, and offering a comfortable spread over Gilts.
One for the road
The issuance of pub WBS has fallen, making the bonds less readily available and the existing bonds more scarce and attractive. Much of the existing paper is held by UK real money accounts - making them relatively less liquid. But for those who have or can gain access to the WBS structures, there can be mileage in trusting in one of Britain’s big social institutions.
[1] Greene King pub giant snapped up by Hong Kong firm CKA - BBC News
