U.K. regulators have resumed investigations into the tenant lease/beer pricing dynamic.
In many cases, a pub company - which is often the property manager - requires its tenants to purchase beer from it in exchange for discounted rent on the property. Under such a scheme, tenants are subjected to unfair competitive practices. This relationship is being looked at by the Trade and Industry Select Committee of the House of Commons.
According to market sources, this is a recurring issue that is unlikely to be resolved soon, and probably will have little effect on pub securitization structures going forward.
"What they are looking at is the relationship between the pub company and the tenant, where the tenant both pays the rent and purchases the beer from the pub company - the beer is bought at off-market prices," said one analyst at Fitch Ratings. "The concern is that it presents an unfair situation where the tenant can't compete on price with dealers on the high street."
The pub sector has up to now proven resilient. According to a Fitch report on the sector published earlier this year, performance over the last year ranged from above to in line with the rating agency's expectations, despite the difficult trading environment defined by an oversupply on the high street and aggressive discounting in the off-trade. Over the past five years, the price of beer in a pub has increased by 4.6% in real terms while the supermarket prices have dipped by 6.2%, said the report.
From a ratings perspective, the current investigation as to whether this price differential is lawful under U.K. competitive laws poses no particular risk to deals because the situation is being resolved among business parties with the resources to afford adequate legal advice. "Pub companies are taking this investigation seriously, prepping their response for the June 2 deadline. The view is that they have seriously looked at this situation before and they don't believe it will have a negative effect once the case is put across (in the third week of July)," said one analyst. "However, politics present an element of uncertainty."
With the price differential gap widening, Fitch believes it could become more difficult for pub companies to continue raising prices significantly. However, Fitch said that it gave no credit for price growth in its analysis of deals.
The agency stressed that under these tied tenant relationship schemes - although the tenant would be subjected to higher beer tariffs - rental income on the property is charged at below- market prices. Pub managers have a choice: They can either work the property as a managed property, buy it "lease free-of-hold" at a higher fixed price or opt for the tied lease that allows the tenant to rent at a discounted price. "It's a less expensive option that any of the other models of operating," said one source.
So why is the subject a recurring controversial theme? Industry sources said there is no clear answer but the latest investigative spell was likely brought on by the acquisitions made by Punch Taverns and Enterprise Inn, which earlier this year purchased the pub holdings of Pubmaster and Unique, respectively. "It puts Punch holdings at almost 8,000 pubs and Unique's at almost 9,000 pubs - there's only 60,000 pubs total in the U.K.," said one market source. "So it takes away some choice from the tenants who now have a much smaller pool to choose from." He added that last year the federation of small businesses approached the Department of Trade and Industry with the same complaint, but this was before the major acquisitions had taken place; at the time, the Department of Trade and Industry thought there was no case for review and rejected the query.
Although industry analysts remain optimistic that the outcome will have little impact on the extensive pub securitization market, following news of the investigation, shares in U.K. pub companies fell by almost 10%. They have since made a moderate recovery. According to analysts at Morgan Stanley, with spread widening, investors should look at the current situation as a buying opportunity. Analysts also noted that the Department of Trade and Industry in the past has established a history of ignoring the findings of the committee inquiries.
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