Mon 1st Dec 2014 - Douglas Jack issues upgrades on Enterprise and Punch Douglas Jack issues upgrades on Enterprise and Punch: Numis Securities' analyst Douglas Jack has issued upgrades on shares in Enterprise Inns and Punch Taverns as the bill containing the "market rent only" (MRO) option enters the House of Lords. Jack argued that the provision, which would effectively eventually end the beer tie, is already factored into the share price of Enterprise and Punch. He said: “The Small Business, Enterprise and Employment Bill has entered the House of Lords. The Bill includes a market rent option (MRO), which would remove the beer tie. If passed, the MRO is likely to be challenged legally, based on contract, competition, human rights and property law. If implemented and adopted by licensees, it would reduce pub buying power, capital investment and tenant support, and lead to 1,400 potential pub closures, according to the government’s own research (by London Economics). The MRO would allow tenants to buy beer/cider anywhere, although this option would only apply to tenants/lessees of companies with more than 500 pubs, creating a two-tier market. Anti-tie lobbyists claim this will ensure “the cost of a pint to consumers remains affordable” and help to keep more pubs open, even though tied pub company retail beer prices are on average 6% lower than free-of-tie retail prices and the tied tenanted pub closure rate is less than half the free-of-tie pub closure rate. Tied pub companies are tied into the success or failure of their pubs. Thus, Enterprise Inns and Punch Taverns spend a combined £170m a year of capital expenditure and support on their circa 9,200 pubs. This investment, which is six to seven times higher than in the free-of-tie sector (using Wellington Pub Company as a proxy), is financed by the central purchasing power that the beer tie guarantees. By contrast, rent is usually collected a quarter in advance in the free-of-tie sector, regardless of the tenants’ trading pattern: if free-of-tie tenants miss a payment, they could lose their pub (and their home).The tied model has been reviewed 25 times since 1966 and been found fit for purpose every time. This includes the OFT stating that tied tenants are no worse off than free-of-tie tenants in 2011, since when tied rents have fallen, tied beer discounts have risen, tied support is up and tied capex is up. We estimate tied and free-of-tie effective rental yields are similar (at 4.5-4.7%). As a result, less than 1% of tied rent reviews are going to arbitration and only a small ratio of licensees asks to go free-of-tie. There is no requirement to change forecasts. If the MRO is passed, it would be at least seven years before it is fully implemented, during which time the pub companies could convert sites into franchised and managed, in order to retain the tie and maintain pub investment. If pubs go free-of-tie, tenants are likely to become tied to the brewers, through loans to cover capital expenditure. That would bring a new tie, but one that engulfs tenants in debt. If the beer tie is undermined, the national brewers should be the main beneficiaries, as the bargaining power that pays for tied pub capital expenditure shifts towards them. We are upgrading our recommendation for Enterprise Inns to 'add' from 'hold' (target price 130p to 125p) and Punch Taverns to 'buy' from 'add' (target price 175p to 160p). In our view, the MRO is already fully reflected in share prices, which should respond favourably to any forthcoming reversal, delay or mitigation of the MRO.”