Fitch Affirms Wellington Pub's Senior Notes; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed Wellington Pub Company's senior class A and B notes with Stable Outlooks, as follows:
GBP115.5m class A fixed-rate notes due 2029: affirmed at 'B+'; Outlook Stable
GBP28.0m class B fixed-rate notes due 2029: affirmed at 'B-'; Outlook Stable.
The affirmation reflects Wellington's operating and financial performance, which is in line with Fitch's base case expectations. The Stable Outlook indicates that the agency does not anticipate a change to the ratings over the next 12 to 24 months. However, the deteriorating asset quality of the portfolio and continuing under-investment represent a risk and may put pressure on the ratings over the longer term.
KEY RATING DRIVERS
Industry Profile - Midrange
While the pub sector in the UK has a long history, trading performance for some assets has shown significant weakness in the past. The sector is highly exposed to discretionary spending, strong competition, and other macro factors such as minimum wages, utility costs and changes in regulation, with the statutory pub code introducing the market rent-only option (MRO) in the tenanted/leased segment in 2016. MRO breaks the traditional tied-model that requires tenants to buy drinks from the pubcos, usually in exchange for lower rent. Finally, the implementation of the national living wage could put margins under further pressure. Despite the on-going contraction, the eating- and drinking-out market is viewed as sustainable in the long term, supported by the strong pub culture in the UK.
(Sub-KRDs: Operating environment: Weaker, Barriers to entry: Midrange, Sustainability: Midrange)
Company Profile - Weaker:
The Wellington portfolio continues to be affected by weak operational performance, reducing number of pubs and on-going low capex spent. Total EBITDA has declined by a CAGR of 6.4% since the peak in March 2008, while EBITDA per pub declined by a CAGR of 4.7% within the same period. Favourable UK macroeconomic trends contributed to a pick-up in performance over the past 24 months. As of June 2015, 12-month EBITDA grew by 1% compared with the previous year. Revenue per pub is 2% higher on a YoY basis, while operating expenses have also increased marginally.
Wellington is actively managing the portfolio by disposing of and acquiring new pubs, but the number of acquisitions is not sufficient to compensate for the closing number of pubs. Positively, the number of pubs on the long lease hold has been stable. The company's low capex adversely impacts the property values and the profitability of the pubs, especially in current market conditions when tenants do not have the financial strength to make sufficient investments themselves. Fitch views this strategy as credit negative. The asset manager estimates that about 48% of the portfolio is suffering from noticeable deferred maintenance (at least GBP5,000 per pub), with 12% experiencing underinvestment of more than GBP20,000 per pub. The total average deferred maintenance costs are estimated to be just under GBP10m.
The tenanted business model has less visibility of the tenants' profitability. As such, the sustainability of the cash flows generated by tenanted pubs is more difficult to estimate. On balance, the nature of the free-of-tie portfolio implies a low level of operational management. Fitch deems the number of available alternative operators to be sufficient in the competitive UK pub industry.
(Sub-KRDs Financial performance: Weaker, Company operations: Weaker, Transparency: Weaker, Dependence on operator: Stronger, Asset quality: Weaker)
Debt Structure - Weaker:
The class A and B notes are fully amortising, secured and fixed-rate. Additionally, the class B notes feature a fixed amortisation amount, which results in reducing class B debt service over time. The security package for the class A and B notes is weakened by the unfavourable ownership structure, whereby pubs are directly owned by the issuer leading to a higher default risk compared with standard WBS issuer-borrower structures. However, the security package is strong, with typical first-ranking fixed and floating charges over the issuer's assets. Notably, the class B notes rank junior to the class A notes.
Structural features are weak due to the non-orphan SPV structure, limited contractual provisions, an inadequate liquidity reserve (covering approximately four months of class A debt service), in addition to the lack of financial covenants, which in other WBS transactions provides bondholders with more control by giving them the option to appoint an administrative receiver well ahead of a payment default. As the liquidity reserve is not tranched among the class A and B notes, it could be depleted by drawings to support the subordinated class B notes, leaving little support for the senior notes. This makes the class A notes more vulnerable than suggested by the average or median debt-service coverage ratio (DSCR). Another weak structural feature is the restricted payment conditions (RPC) covenant, which stipulates that the transaction is subject to a lock-up if the DSCR falls below 1.25x. In practice, despite actual DSCR levels being below 1.25x, a lock-up has never been triggered, since a surplus cash account is taken into consideration when DSCR is calculated under 'cash release income cover test'.
Wellington is the only Fitch-rated free-of-tie pub transaction. However, leased/tenanted pub WBS transactions relying on the beer-tie with the Punch A and Punch B transactions are considered the closest peers, albeit with different business models and revenue streams. Wellington's free cash flow (FCF) DSCRs and debt-to-EBITDA multiples are aligned with its peers relative to their ratings after taking into account the differences in business model and debt structure.
(Sub-KRDs Debt profile: Stronger, Security package: Weaker, Structural features: Weaker)
Negative: A downgrade would reflect a further deterioration in FCF beyond Fitch's base case assumptions as a result of increase in arrears, pub vacancies and/or foreclosure rates and slower than expected deleveraging.
Positive: Upgrade potential is currently limited.
Financial performance over the past 12 months has been stable with debt metrics being in line with the previous year analysis. Fitch's base case FCF DSCR (minimum of the average and median DSCRs to the notes' legal final maturity) for the class A and B notes is 1.23x and 0.98x versus 1.23x and 0.99x in 2014. The minimum class A FCF DSCR under Fitch's base case is 1.14x and is expected to be reached towards the end of the transaction's life. Wellington retained around GBP11.8m of cash deposit as of end-August 2015, which includes GBP6m in liquidity reserves and cash from earlier disposals
SUMMARY OF CREDIT
Wellington is a securitisation of rental income from 778 free-of-tie pubs predominantly located in residential areas, mainly in the south-east of the UK.