Marston's (MARS)

[SlickMongoose]

Low p/e and a high yield, and i'm guessng that the July trading update will be fantastic for those interested in a short term trade (world cup + great weather), however the following jumped out at me:

Return on capital employed: c. 3.5%
Interest on debt: c. 5%

Would anyone here take out a loan at 5% in order to invest it at 3.5%? What am I missing here?

[SDN123]

I don’t mind borrowing (say) £100 at 5.5% for a fixed term to support an endeavour that returns 3.5% on £1,000,000 investment indefinitely.

What are the relevant figures for MARS?

[moorfield]

Would anyone here take out a loan at 5% in order to invest it at 3.5%? What am I missing here?

Well, if the debt keeps getting rolled, perpetually ....

[tjh290633]

Isn't that return after paying interest on the debt?

TJH

[Arborbridge]

Isn't that return after paying interest on the debt?

TJH

According to a couple of definitions I've turned up by Google, it is return on capital employed before interest. Further (from investopedia) "There are no firm benchmarks, but as a very general rule of thumb, ROCE should be at least double the interest rates. An ROCE any lower than this suggests that a company is making poor use of its capital resources.

Read more: Spotting Profitability With ROCE https://www.investopedia.com/articles/s ... z5KOmYGmy0
Follow us: Investopedia on Facebook

Arb.

[monabri]

The ROCE figure is at a particular time point when the books were done. It might be that the company has borrowed money to invest (5%) and - at the moment - the investment is not yet fully paying off and the overall ROCE is currently (3%). It would need to be investigated (if one was so inclined) to understand why they are borrowing money at a rate which is currently higher than the overall ROCE (which would not be good...at all).

[SlickMongoose]

Isn't that return after paying interest on the debt?

TJH

Good point, you're right in this case, thanks. Before interest and tax I make the ROCE around 6.5%.

[blobby]

According to Morning Star ROCE for Marston's is 6.88% and for comparison that for Greene King is 6.38%

I agree if I do the calculations myself I get somewhat different answers. I'm also in the camp that I'd like to see Marston's debt come down and I guess if it did then the company would be better rated. Unfortunately the management don't see it like that.

[ElectronicFur]

I'd also prefer to see debt come down. But then I read in the past that some debt and long maturities can deter takeovers.

This section of the March interim statement might be of interest. Note the final section which states they do intent to reduce the ratio of net debt before lease financing to underlying EBITDA :

"Financing

The Group has a £320 million bank facility to March 2023, with an additional £40 million accordion
facility. This facility, together with a long-term securitisation of approximately £791 million and the
lease financing arrangements described below, provide us with an appropriate level of financing
headroom for the medium term. The Group has sufficient headroom on both the banking and
securitisation covenants and also has flexibility to transfer pubs between the banking and
securitisation groups.

In recent years, the Group has entered into lease financing arrangements which have a total value of
£334 million as at 31 March 2018. This financing is a form of sale and leaseback agreement whereby
the freehold reverts to the Group at the end of the term at nil cost, consistent with our preference for
predominantly freehold asset tenure. The agreements range from 35 to 40 years and provide the
Group with an extended debt maturity profile at attractive rates of interest. Unlike a traditional sale
and leaseback, the associated liability is recognised as debt on the balance sheet due to the reversion
of the freehold.

Net debt excluding lease financing of £1,059 million at 31 March 2018 is £2 million below last year.
Operating cash flow of £63.3 million is 6% ahead of last year reflecting higher profits in the period.
For the period ended 31 March 2018 the ratio of net debt before lease financing to underlying EBITDA
was 4.9 times (2017: 5.0 times). On a pro-forma basis (incorporating the post synergy EBITDA from
CWBB) the leverage figure is 4.8 times. It remains our intention to reduce this ratio over time,
principally through EBITDA growth generated from our new-build investment programme."

[idpickering]

I'd also prefer to see debt come down. But then I read in the past that some debt and long maturities can deter takeovers.

This section of the March interim statement might be of interest. Note the final section which states they do intent to reduce the ratio of net debt before lease financing to underlying EBITDA :

If I may ElectronicFur, here's a link to the item you refer; http://www.marstons.co.uk/docs/financia ... s_2018.pdf

Ian.

[scrumpyjack]

Of course the pub companies borrowed to buy pubs when inflation and interest rates were much higher. At that time they could reasonably expect the property assets they bought to appreciate in value as inflation eroded the currency and the real value of the debenture loans to be eroded by inflation also. Over the years this would give shareholders a very good return.

That game no longer works and the real value of their debenture liabilities is much much higher than the nominal value. A commitment to pay 7% interest for another 20 years on a loan means that the real debt they owe is much much higher. If they were to account for their debts at fair value (as investment trusts do) their balance sheets would look far far worse than the already stretched position.

They have no alternative but to struggle on trying to make enough trading profit to service the debt. They can't pay it off early at par even if they had the cash.

[blobby]

Hi scrumpyjack,

This is a fascinating comment, but I don’t think I understand it yet. I’ve searched the Marston’s annual report for “debenture” and can’t find anything. Can you point me at anything specific for Marston’s to help me understand this.

[pyad]

Of course the pub companies borrowed to buy pubs when inflation and interest rates were much higher. At that time they could reasonably expect the property assets they bought to appreciate in value as inflation eroded the currency and the real value of the debenture loans to be eroded by inflation also. Over the years this would give shareholders a very good return.

That game no longer works and the real value of their debenture liabilities is much much higher than the nominal value. A commitment to pay 7% interest for another 20 years on a loan means that the real debt they owe is much much higher. If they were to account for their debts at fair value (as investment trusts do) their balance sheets would look far far worse than the already stretched position.

They have no alternative but to struggle on trying to make enough trading profit to service the debt. They can't pay it off early at par even if they had the cash.

In the case of MARS you are incorrect about fair value being much higher than balance sheet nominal value.

Note 9 to the latest accounts, the interims to 31 March 18, tells us that the fair value of borrowings of all types in total in £m is 1,573.7. However the carrying value is 1,587.7 so fair value is actually less, in direct contrast to your comment.

[scrumpyjack]

Looking at Marstons accounts, they don’t get to the real details until page 97, until then it is the usual glossy photos and soundbites!
Most of their borrowings is via ‘securitised debt’ some of it not maturing until 2035, the detail is on page 98 of the 2017 accounts. Most of it seems to be on a fixed interest rate of 5.15% to 5.64% but then changing to Libor plus a percentage at various dates up to 2027. That actually looks not to bad but they have used interest rate swaps and derivatives so the real position is hard to fathom. They say there isn't much difference to market value but that may simply reflect the market view that pubcos debts are very risky

They say "All floating rate notes are hedged in full by the Group using interest rate swaps whereby all interest payments are swapped to fixed interest payable."

I don’t have any Marston shares but do hold Greene King. They have substantial amounts of debt liability including securitisations and debentures. Their average interest rate is 6.3% but some of it is up to 9.4% and total long term borrowings were £2.3 billion (gulp!). Green King also use interest rate swaps.
I am very sceptical of these interest rate swaps as I’m sure the bankers who sold them to the pub co’s were far more aware of what they were doing than the finance directors who bought them!

[pyad]

Looking at Marstons accounts, they don’t get to the real details until page 97, until then it is the usual glossy photos and soundbites!
Most of their borrowings is via ‘securitised debt’ some of it not maturing until 2035, the detail is on page 98 of the 2017 accounts. Most of it seems to be on a fixed interest rate of 5.15% to 5.64% but then changing to Libor plus a percentage at various dates up to 2027. That actually looks not to bad but they have used interest rate swaps and derivatives so the real position is hard to fathom. They say there isn't much difference to market value but that may simply reflect the market view that pubcos debts are very risky

They say "All floating rate notes are hedged in full by the Group using interest rate swaps whereby all interest payments are swapped to fixed interest payable."

I don’t have any Marston shares but do hold Greene King. They have substantial amounts of debt liability including securitisations and debentures. Their average interest rate is 6.3% but some of it is up to 9.4% and total long term borrowings were £2.3 billion (gulp!). Green King also use interest rate swaps.
I am very sceptical of these interest rate swaps as I’m sure the bankers who sold them to the pub co’s were far more aware of what they were doing than the finance directors who bought them!

Why not just admit you were wrong about MARS?

Also, their swaps etc. shown as Derivative Financial Instruments in the balance sheet are at fair value, confirmed also in note 9 of the 31 March 18 interims. So even more evidence that fair value in total, including the derivatives about which you are sceptical, is lower than carrying value as at that date. And even if you allow for a bit of approximation error against them, it still doesn't support your view at all that fair value is "much, much higher than the nominal value".

[scrumpyjack]

Happy to admit Marstons don't seem to have a long term debenture problem. I had not seen you reply before posting my comment.

Greene King do seem to have a problem

[pyad]

Happy to admit Marstons don't seem to have a long term debenture problem. I had not seen you reply before posting my comment...

K, thanks.

[ElectronicFur]

I am very sceptical of these interest rate swaps as I’m sure the bankers who sold them to the pub co’s were far more aware of what they were doing than the finance directors who bought them!

What are you sceptical about exactly? Interest rate swaps are simple to understand and pretty common, so I don't really see what the concern is.