VALUE INVESTING
Wolverhampton & Dudley: Another Pub Stripper

By Stephen Bland (TMFPyad)
February 23, 2001

My title stems from the fact that in Wolverhampton & Dudley Breweries (LSE: WOLV)(www.fullpint.co.uk) we have yet another brewery company trying to get rid of a load of underperforming pubs. As many as 1,000, according to the press, for about £400m. Similar pub stripping is being undertaken by the much larger Scottish & Newcastle (LSE: SCTN), a company that figured in my value series a while ago and in which I currently have a couple of sixpacks worth of shares.

Many  breweries trade below book, in a similar way to other property-rich businesses like property companies themselves, hotel companies and so on. The return on this high level of capital invested is often rather small. For years in the brewing game this did not matter too much but in recent times the decline in profitability of traditional pubs, leading to widespread closures, a common sight in the London area which is my patch, has led them to rethink the whole business.

The trend -- fashion, perhaps -- in brewing is to get shot of underperforming pubs. An admirable idea in my view, even if it means selling them at a book loss. If they cannot run them at an acceptable profit then let someone else have a go and realise a load of cash into the bargain. There is consequently a positive epidemic at present of brewery pub sales. Scottish & Newcastle has indicated that despite this, it is finding potential buyers to take the lot off its hands.

The sales are particularly useful to those breweries with substantial debt. Wolves is one of those. Here are the usual fundamentals:

• Share price 450p
• High/low 52 weeks 537p/323p
• High/low five years 705p/323p
• Market cap £425m
• Earnings per share year ended 30/09/00 51.3p normalised
• EPS lowest recent forecast year ending 30/09/01 54.1p
• EPS lowest recent forecast year ending 30/09/02 57.6p
• Yield historical 5.3%; 2001 forecast 5.7%
• Price/Tangible Book 1.0
• Gearing at 30/09/00 97%
• One year relative strength +29%
• Directors own 0.2%; other majors 39.3%

Not a pyad share then in view of the debt, although the other factors are more or less there. P/TB at 1.0 is on the margin. A definite value share though and a mid-cap one. In my view the bigger the better. Value is one area where size matters. Not all players agree with me on that point, though.

EPS is set for a modest rise in 2001, and that is on the conservative approach of the lowest forecast of 54.1p made in January. One broker this month issued a forecast of 60.9p for 2001. Quite a range.

For value players debt is clearly a problem here at 97%, equivalent to about £572m at 30/09/00. This is reflected in the P&L account where interest charges were £40.5m compared with normalised pre-tax profits of £65.0m after interest. Too high.

The salvation, though, comes in the form of the proposed pub sale at a suggested £400m, if it goes through. From press reports it is merely mouth at the moment. But if it goes ahead this will clearly make a major improvement to Wolverhampton & Dudley's debt load.

The company was the subject of bid talk last August. A management buyout was proposed at around 500p but fell through. In fact Enterprise Inns, which is now proposing the pub deal, is headed by the same person that was going to lead the buyout. Following the failure of the bid, the shares fell to 323p and have since recovered to the present price.

Further encouraging indicators are the negative broker comments. All recent recommendations are Hold or Sell. Hold is nearly as bad as Sell anyway in brokerspeak. Very oddly, in my view, the broker forecasting the largest eps of 60.9p for 01, with a further nice rise to 66.1p for 02, makes a Sell recommendation. This was issued in February. As I have said before, forecasts two years out are of far less importance than those for the current year because of the increased risk of inaccuracy, so I tend to concentrate on the current year. Psychologically (and psychology is critical to value investing) it cannot hurt to have a forecast rise two years ahead, for the sake of promoting interest in the share. But don't bank on it actually turning out that way. The usual value approach is to take the money and leg it as soon as the value is outed.

I find it interesting to note that after a large number of construction sector plays about which I have written in this series, most if not all of which have had tremendously successful runs, breweries are now coming within my sights. Now breweries have for years been value plays, but value plays without "outers". They were cheap, but stayed cheap. Not my sort of value share because you have to wait too long, but they had attractions for pure asset players like the US investment company Tweedy Browne, which holds a 6% stake in Wolverhampton.

The outers for me are now appearing in the reorganisations manifested by large-scale disposals of pubs and other assets that can be seen here, in Scottish & Newcastle and more radically with Bass (LSE: BASS) which has exited brewing altogether in favour of hotels and restaurants.

Wolverhampton looks quite attractive. We have rising EPS, a lot of value features especially after the pub sale if it occurs, highly negative broker comment, all of which I see as quite a strong buy signal. But, as always, it may require a lot of patience and belief in the share even if it goes down at first, as value plays often do. You cannot call the exact bottom.

Where Next?

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