Fitch Affirms Mitchells & Butlers
Fitch's overall midrange industry profile assessment for the pub sector cap the class A and AB notes and swap ratings at 'A+', despite strong base case free cash flow (FCF) debt service coverage ratios (DSCRs) at 3.0x and 2.4x, respectively, M&B's best-in-class business profile and WBS debt structure. The Stable Outlook on the class A and AB notes and the swaps reflects substantial buffer in the financial metrics of the notes and swaps to absorb material deterioration in EBITDA, beyond that what we expect from the introduction of the National Living Wage.
The junior note ratings reflect the financial performance in the year to April 2016 being slightly ahead of Fitch's base case as well as the financial metrics of the class B, C, and D notes being in line with peers and our criteria. Fitch retains the Negative Outlook on the notes as we expect the introduction of the National Living Wage to increase wage costs and put pressure on M&B's profitability. Ongoing low revenue growth remains a risk in particular as the vote to leave the EU has cast uncertainty on discretionary spending.
EBITDA in the year to April 2016 increased 1.4% yoy to GBP363m, ahead of the previous Fitch base case despite a decline in the number of pubs during the year. EBITDA per pub of GBP255,000 (GBP251,000 to Apr 2015) equated to a yoy increase of 1.7%. Twelve-months to April 2016 FCF was GBP287m (GBP286m in 2015), which resulted in 52-week EBITDA and FCF DSCRs of 1.9x and 1.5x, respectively, unchanged from 2015.
We project base case FCF to grow by a CAGR of 0.2% over the life of the transaction but declining by 0.4% on average over the first 10 years of the projection period. This is a result of moderate expected sales growth combined with the expected cost pressures due to the National Living Wage target (GBP9 by 2020 for those aged 25 and over).
We forecast base case FCF DSCRs for class A and AB notes at 3.0x and 2.4x, respectively. The base case FCF DSCRs (minimum of the average and median DSCR) for the most junior tranches B, C and D remain at 1.6x, 1.5x and 1.4x respectively, with a minimum 1.5x, 1.4x and 1.3x. Although the metrics are unchanged since our last rating action a year ago, we have revised some assumptions: a slight reduction of sales growth in the near term, mirroring the observed sales decline as well as the uncertain impact of Brexit on discretionary spending; higher capex assumptions reflecting the historical overspend above required levels as well as moderated cost assumptions as the impact of the National Living Wage in the first few months of 2016 has not resulted in the expected cost increase.
Net debt-to-EBITDA remains low compared with peers and has reduced further over the last 12 months to 2.1x (from 2.3x), 3.0x (3.2x), 4.3x (4.6x), 5.0x (5.3x) and 5.3x (5.6x) 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 for class A to D notes in total falling gradually to around 4.7x until 2021.
KEY RATING DRIVERS
Industry Profile: Midrange
The pub sector in the UK is mature and the strong pub culture is expected to persist. Forecast population growth is credit-positive. However, the pub sector is highly exposed to discretionary spending, strong competition including from the off-trade, and external factors such as commodity costs and potential changes in regulation. Existing licencing laws and regulations are moderately stringent, and managed pubs are fairly capital-intensive, creating some barriers to entry. Switching costs are generally viewed as low, even though there may be some captive market effects.
Sub-Key Rating Drivers: Operating Environment: Weaker; Barriers to Entry: Midrange; Sustainability: Midrange.
Company Profile: Stronger
M&B is a large operator of restaurants, pubs and bars in the UK, including a range of strong brands aimed at both the more expensive and value-end of the market. The company's trading history (12-year revenue CAGR of 2.4%) has shown resilience to declining UK pub industry fundamentals. However, growth has slowed in recent years, with like-for-like sales growth in the financial year to September 2015 at 0.8% and FY16 expected to be slightly negative due to the weak performance of the value-end brands. A repositioning of underperforming sites and focused capex should help to address weak sales going forward. The presence of a fairly large pension deficit (GBP572m in 2013) is credit-negative.
The securitised portfolio includes 1,421 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 visibility over underlying profitability. Operator replacement is not viewed as straightforward but is possible within a reasonable period of time. The pubs are well-maintained and feature a high minimum maintenance covenant. Furthermore, M&B has shown a history of maintenance capex in excess of the required level. Maintenance spend over FY15 was GBP142m compared with a minimum requirement of GBP92.7m. 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, IRS and FX swaps - 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 ranking lower, resulting in a 'Midrange' assessment. A minimum maintenance requirement of the greater of 5.7% of turnover and GBP35,000 per pub (indexed) annually 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, which are tested quarterly.
Fitch views the creditworthiness of the issuer's obligations under the interest rate and cross currency swaps as consistent with the long-term ratings of the most senior class of rated notes, as the swaps are expected to default with the notes under certain scenarios.
Sub-KRDs: Debt Profile: 'Stronger' for the class A notes and swaps and 'Midrange' for the class AB, B, C and D notes, Security Package: 'Stronger' for the class A notes and swaps and 'Midrange' for the class AB, B, C and D notes. Structural Features: 'Stronger' for all notes and swaps.
M&B's Class A and AB notes are rated at the pub sector rating cap and higher than any other senior debt tranches in Fitch's WBS pub portfolio due to the group's strong financial metrics. We view the junior notes as well-aligned with its pub peers. Their slightly lower FCF DSCR compared with Green King and Marston's indicate limited room for deterioration in coverage. M&B's junior notes' coverage levels and ratings equate to the senior tranches of Greene King and Marston, which benefit from a first-ranking security over assets in contrast to their junior claim. Positively M&B's EBITDA leverage metrics are marginally lower than some peers with the same ratings. A further strength is M&B's more reactive and transparent business model as a result of being the only fully managed estate among Fitch-rated peers.
Positive: class A's and AB notes' ratings are constrained by the industry cap applicable to WBS pub transactions.
For class B, C and D notes, an improvement in Fitch's base case FCF DSCRs to above 2.0x, 1.7x and 1.6x could lead to positive rating action, when combined with further deleveraging expected over the next few years. In Fitch's base case these DSCR levels are only achieved post class A maturity.
Negative: A decline in Fitch's base case FCF DSCRs (1.6x, 1.5x and 1.4x for class B, C and D respectively) due to persistent underperformance against expectations could lead to downgrades of the class B, C and D notes. The class AB notes could also see a revision in Outlook to Negative if FCF DSCR deteriorates to around 2.2x.
SUMMARY OF CREDIT
M&B is a whole business securitisation of a portfolio of 1,421 managed pubs and pub restaurants in Britain owned and operated by Mitchells & Butlers Plc (representing 80% of the M&B plc's pubs).
The rating actions are as follows:
GBP200m Class A1N floating-rate notes (outstanding as of Jul 2016 GBP153.9m) due 2030: affirmed at 'A+'; Outlook Stable
GBP482m Class A2 fixed-rate notes (GBP280.1m) due 2030: affirmed at 'A+'; Outlook Stable
USD418.8m Class A3N floating-rate notes (USD322.3m) due 2030: affirmed at 'A+'; Outlook Stable
GBP170m Class A4 floating-rate notes (GBP170m) due 2030: affirmed at 'A+'; Outlook Stable
GBP325m Class AB floating-rate notes (GBP325m) due 2033: affirmed at 'A+'; Outlook Stable
GBP350m Class B1 fixed-rate notes (GBP139m) due 2025: affirmed at 'BBB+'; Outlook Negative
GBP350m Class B2 fixed-rate notes (GBP341.8m) due 2030: affirmed at 'BBB+'; Outlook Negative
GBP200m Class C1 fixed-rate notes (GBP200m) due 2032: affirmed at 'BBB'; Outlook Negative
GBP50m Class C2 floating-rate notes (GBP50m) due 2034: affirmed at 'BBB'; Outlook Negative
GBP110m Class D1 floating-rate notes (GBP110m) due 2036: affirmed at 'BBB-'; Outlook Negative
Mitchells & Butlers Finance Plc interest rate swap affirmed at 'A+'; Outlook Stable
Mitchells & Butlers Finance Plc cross currency swap affirmed at 'A+'; Outlook Stable
The swap ratings address the issuer's ability to make payments under the swap agreements as per the transaction documentation, excluding swap termination payments due to default or non-performance of the counterparty. The ratings also do not address events related to a change in law or taxation.
Fitch applied its 'Rating Criteria for UK Whole Business Securitisations', 'Counterparty Criteria for Structured Finance and Covered Bonds' in addition to applying certain elements from its 'Criteria for Rating Currency Swap Obligations of an SPV in Structured Finance and Covered Bonds' relating to counterparty default and non-performance, tax events and illegality.