Young and Co’s Brewery PLC
I recently mentioned, commenting on Jayden Preston’s excellent post analysing the Cheesecake Factory, one of my holdings, Young and Co’s Brewery PLC (“Young’s”). I thought it would be interesting to do a write-up of the company as it’s a very interesting company and also one that, I suspect, most members may not have heard of.
You can find information on the company here:
http://www.youngs.co.uk/investors
https://beta.companieshouse.gov.uk/company/00032762/filing-history?page=1 [this link is to Young’s entry at the registry of publicly available company filings in the UK – if you select “accounts” you can read a selection of Young’s annual accounts going back to the 1970s.]
I will first provide a very brief overview of the company before setting out a bit more detail of why I think it is an interesting company to follow, and one that should provide an acceptable investment return over time.
Overview
Young’s own and operate circa 170 pubs in London and the South East of the UK (despite the name, Young’s do not do any brewing – see further below). These pubs are positioned firmly at the premium end of the market and offer food and drink in well maintained, characterful pubs (each with its own individual character), but also a clear, consistent, identifiable company-wide brand. So, basically, like CAKE, Young’s operates in the casual dining sector, but (in a way that I think is uncommon outside the UK) combines both casual dining and bar-style drinking.
They explain their business model very simply as operating premium, individual and differentiated pubs – operating well invested pubs at the heart of their communities, primarily in London and the South East.
Ownership
Before going into the detail of Young’s business, there are three factors I think most Focused Compounding members would agree are investment positives for Young’s and which I think mean that any long term, business focused investor should be interested in the company:
- The stock is relatively illiquid
- The company is still family-controlled
- There are two classes of share, voting and non-voting. The non-voting shares typically trade at a substantial discount to the voting shares – currently c22%.
The non-voting shares are identical in rights to the voting shares except for voting (so you get the same dividend, would get the same price in any takeover (extremely unlikely), etc.) – you just don’t get to vote on shareholder resolutions. The value of a vote is however negligible – so if you do invest in Young’s you should always buy the non-voters.
Overview of the Business
Young’s was founded in 1831 as a brewery and pub company, taking over the Ram brewery in Wandsworth, south-west London, and five pubs. Over the ensuing years, the company gradually built up its estate of pubs, which now stands at c170, with a further c80 “tenanted” pubs (that is, pubs where Young’s owns the property and leases it to a tenant who manages the pub, in return for rent and other fees). Young’s sold the brewery arm of the business in 2006.. And they are gradually expanding accommodation so that some of their pubs are also hotels. Basically they’re now just a pub company, rather than a pub and brewing company. But, that detail aside, they are still in the same business now as they were in 1831.
Basically, Young’s has a very simple business model: to own and operate pubs in good locations in affluent areas, providing high quality food and drink, in characterful and friendly surroundings. Each of those pubs has its own individual character (and some of them are very old) but they are also all identifiably “Youngs” pubs.
Durability
The durability of the business of restaurants and bars (and a modern day pub is essentially a hybrid of a restaurant and a bar) is very high. Jayden commented on this in his post on the Cheesecake Factory, and it’s equally true for Young’s. I personally have eaten and drunk in pubs that are 400 years old or older – they serve such basic human needs of eating and drinking out, needs that it is hard to imagine ever going extinct.
However, the durability of individual restaurants, bars and pubs is low. That’s because there are few barriers to entry into the sector, and there are also (as Jayden identified) trends and fashions within the eating and drinking out industry – so, a particular concept may experience strong growth and returns, but may not be durable over time.
There are a number of reasons to think that Young’s is an unusually durable business even in a sector where individual business models face risks to durability. The three key ones in my view are as follows.
First, Young’s has an extremely strong historical record of durability. The business was founded nearly 200 years ago and has developed and expanded over decades in which it has faced enormously varying macroeconomic and industry environments. So, it has demonstrated durability in the past.
Secondly, Young’s is not tied to a particular cuisine, a particular brand of beer, or a particular concept. If there is a Young’s “concept” it is more generic – tasteful, characterful, historic pubs serving modern, high quality food and drink. That is a very adaptable business model. So, in recent times, Young’s has been able to adapt its menu to accommodate food trends. And, because it’s not “tied” to a particular brewery, it can source beer (and other drinks) from any supplier. So it has been able to adapt to recent trends such as the rise of craft beers, the rise of craft gins, etc. It can simply incorporate those trends into its pubs. A competitor that is tied to a particular food concept, or tied to a particular brewery (in the sense of being obliged to source their products from that brewery – this is a unique feature of many pubs in the UK) cannot adapt so easily.
Thirdly, location is (obviously) a hugely important factor in determining how well a restaurant business will do over time. Young’s estate of pubs is very well located. They occupy key sites (often with historic resonance) in affluent, high footfall areas. Their estate is predominantly freehold (I.e. they own the land, they don’t lease their premises from commercial landlords). They also have some leasehold premises – but often those leases are very long leases. So, they have a combination of (1) excellent locations and (2) exceptionally high certainty of retaining their position in those locations.
The UK is densely populated. London and the South East (where Young’s is located) is exceptionally densely populated. Anyone trying to compete with Young’s has to find suitable sites, likely at a very high cost, and fight off high competition for those sites. Obviously this does not insulate Young’s from competition – there are a lot of restaurants and bars in London. But, it does mean that they are almost always operating from a stronger and more secure position than many of their competitors.
Moat
Does Young’s have a moat? This is a question I think reasonable people could disagree on. There’s no doubt the company operates in a competitive sector. And it certainly cannot prevent its customers going to eat and drink at its competitors. However, Young’s has an identifiable brand and reputation, and a very strong location advantage. I think the combination of these factors means that Young’s is a difficult company to compete with and enough for me to say that, while it doesn’t have a moat in the sense that a company with a monopoly product, it does have a strong, hard to replicate competitive position.
Finances and returns
I’ve posted below key financial results from Young’s over the past 10 years.
|
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
2013 |
2014 |
2015 |
2016 |
2017 |
|
|
Revenue (£m) |
126.6 |
122.1 |
126.1 |
127.5 |
142.6 |
179 |
193.7 |
210.8 |
227 |
245.9 |
268.9 |
|
Operating Profit |
15.4 |
20.9 |
20.5 |
20.3 |
21.7 |
26.2 |
28.9 |
33.3 |
37.4 |
41 |
46.1 |
|
Operating Margin |
12.16% |
17.12% |
16.26% |
15.92% |
15.22% |
14.64% |
14.92% |
15.80% |
16.48% |
16.67% |
17.14% |
|
PBT |
46.3 |
10.8 |
5.1 |
18.4 |
15.3 |
-8.6 |
22.3 |
26.6 |
36.1 |
33.3 |
37 |
|
Adj EPS |
18.45 |
26.19 |
27.77 |
28.71 |
32.65 |
33.41 |
37.74 |
42.69 |
50.54 |
57.17 |
61.51 |
|
Total Assets |
328.7 |
288.1 |
293.4 |
290.8 |
365.9 |
543.1 |
561 |
595.3 |
654.3 |
714.8 |
742.5 |
|
NAV PS |
429.83 |
246.09 |
342.83 |
350.21 |
376.46 |
658.99 |
693.79 |
786.39 |
840.98 |
938.04 |
1010.81 |
|
Net Debt |
101.2 |
50 |
65.3 |
62.2 |
122.6 |
118.1 |
112.6 |
112 |
129 |
130 |
126.6 |
|
Return on assets |
4.69% |
7.25% |
6.99% |
6.98% |
5.93% |
4.82% |
5.15% |
5.59% |
5.72% |
5.74% |
6.21% |
You can see from these results that the business has increased its profits significantly over this period, but also that, while Young’s may be a good business, it’s not exceptional, because those returns have come from continually increasing increasing assets employed. To be fair to Young’s, they have paid a dividend over this period of time. Overall, operating profit has compounded at c11%, and there’s been a dividend of c2% per year on top of that. So, assuming constant valuations, Young’s has compounded value for investors at around 13% per year over the past 10 years. It’s also deleveraged over this period of time. (In fact, in 2007 Young’s was considerably more expensive than it is today – but I am trying to set out what the business may be capable of delivering.)
One key point to be aware of is that Young’s accounts for its property, plant and equipment at fair value. That means that, each year, it revalues its substantial estate of freehold property. The values have tended to go up over time. So, this means that any profitability calculations (return on equity, return on capital employed, etc) look very low. But the increase in value of Youngs’ estate is not growth that shareholders have to pay for. So, I have attempted to calculate Youngs’ returns stripping out the revaluation element of the capital base. It’s not easy to do, but basically I get a cash return on capital of something like 11%, and a cash return on equity of something like 15% (as the business is leveraged). Not spectacular returns, but consistent ones, and similar to the return in the stock over time (which gives me comfort that my estimate is broadly accurate).
Incidentally – the long term return in Young’s stock for as far back as I can find the figures (1994) to is good. The capital-only return for Young’s is c1,000% over this period, so, including a dividend of on average 2%, the return over this period is around 12% a year – comfortably better than both the stock market (whether FTSE or S&P 500) and benchmark stocks such as Berkshire.
Growth
Clearly, Young’s has been able to grow strongly over the past decade. What are the growth prospects for the next 10 years?
There are three potential growth sources for Young’s. First, increasing same store sales. Second, acquiring or building new pubs. And third, increasing margins.
Margins
I am going to eliminate margin growth as a possibility. There are numerous near term headwinds to margins in the pub and restaurant sector – increases in the minimum wage, increases in property taxes, inflation, and a tight labour market. So, I do not think it is realistic to expect margin increases in the near term (in fact, the opposite may be the case) and management have not suggested they are targeting a particular level of margin in the medium term. In fact, Young’s have been able to increase margins over recent years, and they may be able to do so over the medium term future. But I think assuming they can is speculative.
Same store sales
Young’s have managed very impressive same store sales growth (“like for like” as they term it). Over the last six years, like for like sales growth in the managed pubs segment of the business – by far the most important – has been 6%, 4.6%, 6.7%, 6.5%, 5.6%, 4.7%, and the recent interim results show this trend continuing with like for like growth of 4.6%. These are very impressive figures, consistently outperforming the industry. They do need to be treated with a little bit of caution, because (while it’s not possible to be certain) I think they include existing pubs in the estate where substantial renovations are carried out (e.g., doubling the size of the kitchen). So arguably, you could say that Young’s are “cheating” a little on this. However – I am going to allow for this in my assumptions of how much profit Young’s can return to investors. I think long term like for like growth of 3.5 – 5% is realistic: say 3% nominal GDP growth plus 0.5 – 2% outperformance due to premium positioning, excellent locations, entrepreneurial management, and a consistent, well invested estate.
New pubs
Young’s have increased the managed estate from 112 pubs in 2005 to 173 in 2017 – a compound rate of 3.7%. Given the business’ requirements for well located pubs in a restricted geographical area, and its conservative management, Young’s will not be expanding quickly – it’s not a rollout situation. But, management are starting to expand outside their core south-west London region into the rest of London and the home counties (broadly, the wealthy commuter belt outside London) and even further afield into the Southeast in areas such as the Cotswolds (a wealthy, picturesque region attracting a lot of tourists and wealthy residents). I think this strategy makes a lot of sense. So, there is definitely scope for Young’s to gradually acquire more pubs. Medium to long term growth of say 3.5 – 4.5% in total number of pubs seems realistic.
So – that gives total growth in a range of 7 – 9.5%, assuming no further margin increases. (In fact – if Young’s achieve the upper end of my like for like growth estimate, I think there would be some margin increase. However, that’s not a given.)
Capital allocation
Young’s capital allocation is consistent and predictable, but also quite conventional. I don’t think that substantial added value will come from capital allocation. The track record here is fairly clear. Basically, Young’s will use their profits to:
- Invest in the existing estate (renovation, maintenance, and upgrades)
- Acquire new pubs in good locations at reasonable prices
- And pay a dividend that increases broadly, over time, in line with the increase in profits.
So, I don’t think that huge value will be created by capital allocation – but I don’t think that big risks will be taken either, or value destroyed.
Valuation
Enterprise level valuation metrics cause problems with Young’s, due to the split share structure, with the non-voters typically trading at a substantial discount to the voting shares.
So, a really simple way of looking at the likely return in Young’s is to take the current dividend yield – 1.7% – and assume that (i) over the next 5 – 10 years, the dividend increases in line with the growth range I set out above and (ii) the valuation remains constant (which it obviously won’t – but it’s a useful simplifying assumption).
That gives a potential return of 1.7% + 7% – 9.5%, so a total return in the range of 8.7% – 11.2%. This is actually quite close to the long-term return in Young’s (slightly lower, in fact, but this method arguably penalises the business as the dividend payout ratio is currently lower than the historical average as the business has deleveraged and reduced its payout ratio over the last few years, so, there is scope to increase dividends more quickly in future).
Alternatively, I like to look out ten years into the future, projecting what the business’ earnings will be in the 10th year, accumulating all the dividends received in that time frame, and calculating what multiple of my current capital that gives. Doing that calculation (using mid-range growth of 8%) gives:
Current EPS of 66p x 1.08^10 = 2027 EPS of 142.5p
142.5p x average P/E of 15x = £21.37
£21.37 + (10x average dividend of 21p x 1.5 [to account for reinvestment]) = £21.37 + £3.15
= total value in year 10 of £24.52
= 2.26x today’s price of £10.85, or a compound growth rate of 8.5%.
Basically – I think Young’s will provide an acceptable return at today’s price. Certainly the stock should return more than the broad market indices. And I think there is potential upside if the business can either grow at the higher end of the range I set out, or can continue to achieve margin improvements.
Clearly, if Young’s were to decline in price by say 10 – 20%, there would be a clearer path to 10%+ returns.
That said – Young’s is the kind of share you can own and build wealth slowly. But, it’s not the kind of share to buy if you want to make money quickly.
Misjudgement
I think the major areas of potential misjudgement are capital intensity and inflation.
First, Young’s is in a capital intensive business and there is evidence from competitors that capital intensity is increasing. For example, Mitchells and Butlers (London: MAB), which operates a much larger estate of pubs over a much larger geography (and is clearly an inferior business), recently said to analysts that the investment cycle (i.e. the length of time between renovations) at their pubs had shortened considerably. Obviously, that means that capex will increase and the current depreciation charge is probably inadequate. Clearly, if that were to affect Young’s, the numbers I’ve outlined above for total return would drop significantly.
I don’t think there’s much sign of this at Young’s. First, capex as a percentage of turnover has been relatively steady and there certainly wasn’t any sign in the most recent results of it spiking upwards. Also, Young’s is already positioned at the premium end of the market. Many of its competitors (e.g. Mitchells & Butlers) are not. So, I think Young’s was already maintaining its properties to a high standard. Certainly, I have never been to a Young’s pub that was shabby. But I have been to MAB or Greene King (London: GNK) pubs which are shabby. So overall, this doesn’t concern me.
Secondly, inflation. This is really tied to the fact that Young’s is at least moderately capital intensive and earns returns from tangible assets which it needs to continually renovate. The clear risk here is that if inflation really picks up in the UK, then Young’s will find itself struggling to fund its renovations without cutting returns to shareholders. Personally, I think in an inflationary environment, the fact Young’s has premium positioning, as an affordable but high quality treat, means it will be able to pass on much of the inflation to its customers. It’s only really high inflation that would concern me – not moderate inflation. However, there’s no doubt that if we do see high inflation, there are businesses that are better placed to do well than Young’s.
Peers
I haven’t analysed them here, but the following are peer companies that may be of interest:
Fuller, Smith & Turner (FSTA) – the best peer for Young’s, with almost identical positioning and similar family control. Still owns its brewery. Unlike Young’s though, there is only one class of shares.
Mitchells & Butlers (MAB) – a large, nationwide chain of pubs with a variety of brands
Marston’s (MARS) – a brewer and pub chain based in the Midlands – not a bad company but less well positioned geographically than Young’s
Greene King (GNK) – a large brewer and pub chain which has recently done an acquisition which in my view diluted the quality of its estate