Mitchells & Butlers plc – Annual report – 24 September 2022
Industry: food and drink
Notes to the consolidated financial statements (extract)
The Group’s business activities, together with the factors likely to affect its future development, performance and position are set out in the Strategic Report on pages 10 to 58. The financial position of the Group, its cash flows, liquidity position and borrowing facilities are also described within the Financial Review on pages 55 to 58.
Note 4.3 to the consolidated financial statements includes the Group’s objectives, policies and processes for managing its capital; its financial risk management objectives; details of its financial instruments and hedging activities; and its exposures to credit risk and liquidity risk. As highlighted in note 4.1 to the consolidated financial statements, the Group’s financing is based upon securitised debt and unsecured borrowing facilities.
The Directors have adopted the going concern basis in preparing these financial statements after assessing the impact of identified principal risks and their possible adverse impact on financial performance, specifically revenue and cash flows.
The combined impact on the hospitality sector of Covid-19, Brexit and more recently high and persistent cost inflation, initially in energy, wages and food costs, but now evident throughout most of the Group’s cost base, has resulted in reduced levels of sales, profits and operating cash flow since March 2020. These factors cast a high degree of uncertainty as to the future financial performance and cash flows of the Group and have been considered by the Directors in assessing the ability of the Group to continue as a going concern.
The Group’s primary source of borrowings is through ten tranches of fully amortising loan notes with a gross debt value of £1.4bn as at the end of the period. These are secured against the majority of the Group’s property and its future income streams. The principal repayment period varies by class of note with maturity dates ranging from 2023 to 2036, with £116m amortisation payments falling due within the going concern period.
The Group also has available a committed unsecured credit facility of £150m which has a maturity date in February 2024. At the balance sheet date there were no drawings under these facilities.
Last year the Group launched an Open Offer to shareholders resulting in an inflow of £351m of additional funds, gross of transaction costs, on 12 March 2021. This significantly enhanced the financial position of the Group. Further, and contingent on this equity raise, new debt arrangements were secured by agreement with the Group’s main stakeholders. In summary:
- The establishment of the £150m 3 year unsecured revolving credit facility due to expire in February 2024, referred to above.
- Agreement to a number of covenant waivers and amendments with Ambac Assurance UK Ltd, as controlling creditor, and HSBC Trustee (CI), as trustee, running until January 2023 to provide flexibility and stability to manage the Group’s secured debt financing structure.
Within the secured debt financing structure there are two main covenants: the level of net worth (being the net asset value of the securitisation group) and, FCF to DSCR. As at 24 September 2022 there was substantial headroom on the net worth covenant. FCF to DSCR represents the multiple of Free cash Flow (being EBITDA less tax and required capital maintenance expenditure) generated by sites within the structure to the cost of debt service (being the repayment of principal, net interest charges and associated fees). This is tested quarterly on both a trailing two quarter and a four quarter basis. These tests were waived until January 2022 (two quarter) and April 2022 (four quarter) and then set as transitioning to their full level of a minimum of 1.1 times by January 2023.
Unsecured facilities were initially measured only against a liquidity covenant, against which there was substantial headroom, until the end of Q3 FY 2022. Following this date further covenants were introduced relating to the ratio of EBITDAR to rent plus interest (at a minimum of 1.5 times) and net debt to EBITDA (to be no more than 3.0 times) based on the performance of the unsecured estate, both tested on a half-yearly basis.
In the year ahead the main uncertainties are considered to be the maintenance of growth in sales in the face of pressure on consumer spending power in an environment of falling real wages, and the future outlook for cost inflation across the whole of the cost base but most notably in energy prices, food costs and wages and salaries. The outlook for these is highly uncertain and volatile, particularly energy costs in the second half of FY 2023, and will depend on a number of factors including consumer confidence, global political developments and supply chain disruptions and government policy.
The Directors have reviewed the financing arrangements against a forward trading forecast in which they have considered the Group’s current financial position. This forecast assumes further growth in sales beyond pre-pandemic levels and on the prior year slightly below the level generated in recent months. Costs are also assumed to continue to increase in line with recent experience blending at an expected increase of c10% across the cost base of the business of approximately £1.8bn. Under this base case the Group is able to stay within revised committed facility financial covenants, albeit with limited headroom, and maintains sufficient liquidity.
The Directors have also considered a severe but plausible downside scenario covering adverse movements against the base forward forecast in both sales and cost inflation in which some, but limited, mitigation activity is taken including lower capital expenditure on site remodel activity and a flex down of labour costs in line with reduced sales. In this scenario sales are assumed to remain in growth but at a level further below current run rates, and the impact of unmitigated cost inflation is higher particularly in the areas of food, labour and energy aggregating to 12% of the cost base. In this downside scenario, whilst the Group retains sufficient liquidity throughout the period based on existing facilities, covenants would be breached in the fourth quarter of the year in both secured and unsecured facilities. Under such a scenario the Directors believe that, on the basis of previous waivers secured, the strong asset base and longer term trading prospects, waivers should be forthcoming from main stakeholders. However this is not within the Group’s control and as a result the Directors cannot conclude that the possibility of an un-waived breach of covenant is remote.
After due consideration of these factors, the Directors believe that it remains appropriate to prepare the financial statements on a going concern basis. However, the circumstances outlined above, in particular the uncertainty concerning sales and cost inflation with the resulting possibility of an un-waived covenant breach, and ultimately the need to renew unsecured facilities on or before February 2024, indicate the existence of a material uncertainty related to events or conditions that may cast significant doubt over the Group’s and the Company’s ability to realise their assets and discharge their liabilities in the normal course of business. The financial statements do not include any adjustments that would arise from the basis of preparation being inappropriate.
A review of longer-term viability is provided on pages 52 and 53 which assesses the Group’s ability to continue in operation and to meet its liabilities as they fall due over a longer, three year period.
Corporate Viability Disclosure (page 52)
In accordance with Provision 31 of the 2018 UK Corporate Governance Code, the Directors have undertaken an assessment, including sensitivity analysis, of the prospects of the Group for a period of three years to September 2025.
Three years continues to be adopted as an appropriate period of assessment as it aligns with the Group’s planning horizon in a fast moving market subject to changing consumer tastes in addition to economic and political uncertainties, and is supported by three-year forecasts as approved by the Board. This period also aligns with the triennial process for pensions valuations, a consideration in respect of future cash flows. Beyond this period, performance is impacted by global macroeconomic and other considerations which become increasingly difficult to predict. As set out below, this is particularly so at the current time.
Assessment of prospects
The Group’s financial planning process comprises a detailed forecast for the next financial year, together with a projection for the following two financial years.
The Group’s strategy seeks to provide long-term direction to protect the viability of the business model given prevailing and evolving market and economic conditions. The Directors’ assessment of longer-term prospects has been made taking account of the current and expected future financial position and the principal risks and uncertainties, as detailed within the Annual Report.
At the current time uncertainty facing the business remains particularly high due both to challenging and potentially volatile conditions as a result of the extended impact of both Covid-19 and Brexit, and to global political developments, supply chain disruptions and uncertain government policy, and to increasing cost headwinds in areas such as energy, wages and food costs. These are exacerbated by concerns over consumer spending power in the face of falling real wages. Longer-term risks are further identified around evolving consumer demands and tastes and the economic and political environment.
Key factors considered in the assessment of the Group’s prospects are a strong market position with a broad range of brands and offers trading from a well-positioned and largely freehold estate, supported by the resumption of capital investment focused on premiumisation of offers and an appropriate remodel cycle, all anticipated to contribute to outperformance against the wider market.
Assessment of viability
The current funding arrangements of the Group consist of £1.4bn of long-term securitised debt which amortises on a scheduled profile over the next 14 years. Securitisation covenants are tested quarterly, both on an annual and a half year basis, although as set out in the note to the financial statements on going concern, a refinancing was undertaken during the prior reporting period, resulting in a number of waivers and amendments through to January 2023 being obtained. Unsecured committed facilities of £150m were in place at the year end, having been extended during the refinancing and equity Open Offer. These facilities expire within the three-year term of this assessment, in February 2024.
Following the end of the third national lockdown in 2021 sales have returned to growth above pre-pandemic levels such that the principal short-term risks facing the business are now assessed to be the maintaining and generating of further growth on this level of demand, in addition to increased cost inflation notably in energy, wage rates and utilities. The Group has reviewed a number of forecast scenarios and sensitivities around these risks, including additional stress testing that has been carried out on the Group’s ability to continue in operation under unfavourable operating conditions. In making this assessment the Group has taken the view that there will be no material further adverse impact of Covid-19 (or any other pandemic) such that sales will continue to grow year-on-year. In particular it is assumed that no further mandated closure or trading restrictions will be reintroduced. Through the assessment period, the Group is forecasting sales growth against last year remaining at close to current levels. Further, it assumes that on a general basis the current very high levels of cost inflation will start to abate beyond FY 2023 and that energy markets and costs in particular will start to revert to closer to historical levels in absolute terms through FY 2024 leading to a recovery in profitability over the assessment period.
The Group’s three-year plan takes account of these risks, in addition to the prevailing economic outlook and capital allocation decisions, alongside limited mitigating activity such as improved operational efficiencies (stock and labour management and energy saving initiatives) to manage these costs. In the base case scenario the Group remains within solvency covenant limits and has access to sufficient liquidity to meet its outgoings. It is noted that there is a requirement to refinance the unsecured facilities and potentially increase the amount in February 2024. It is considered that this can be accommodated within the debt capacity of the business given future anticipated recovery in profit and the strength of the creditor relationships exhibited in the refinancing exercises during FY 2020 and FY 2021, noting also that each year a further c. £120m of securitised debt is expected to have been paid down. The resilience of this base case plan is then assessed through the application of forecast analysis, focused in particular on growth of demand and high levels of input cost inflation during the current financial year as well as on a longer-term basis. Sensitivities of the following risks described in the Annual Report have also been applied individually to the base plan. In all scenarios the Group remains profitable but with the following impact on liquidity and solvency based on financial covenants (Risk event 1) on both secured debt and unsecured facilities:
- Declining Sales Performance (Risk event 2): Lower like-for-like sales growth rate in FY 2023, FY 2024 and FY 2025 of approximately 2% pa, with the outcome that covenants would be breached in the second half of FY 2023 and beyond.
- Cost of Goods Price Increases (Risk event 9): Increase in direct Cost of Goods (Drink and Food) resulting in margins 2 ppts lower in the second half of FY 2023, and 0.5 ppts lower through FY 2024 and FY 2025, with the outcome that covenants would be breached in the second half of FY 2023 and beyond.
- Increased utilities cost (Risk event 9): additional £20m costs in the (uncapped) second half of FY 2023, with reductions delayed until FY 2025, with the outcome that covenants would be breached in the second half of FY 2023 and beyond.
- Increased Wage Cost Inflation (Risk event 6): 1.5% increase in statutory NLW wage rate in FY 2023, with no forecast covenant breaches but limited, or no, headroom.
As noted above, in the base case there is a requirement to refinance unsecured facilities before February 2024 and potentially increase the amount. With Declining Sales Performance and Cost of Goods Price Increases this would be required earlier, in FY 2023, as it would in a scenario representing an aggregation of all downside sensitivities. In all other individual sensitivities refinancing would not have to be undertaken earlier than in FY 2024.
The Directors have concluded, based upon the extent of the financial planning assessment, sensitivity analysis, potential mitigating actions and current financial position that there is a reasonable expectation that the Group will have access to sufficient resources to continue in operation and meet all its liabilities as they fall due over the three-year period to September 2025. However, due to the prevailing high level of unpredictability and uncertainty concerning both future demand and the persistence of high levels of cost inflation, the Directors do not believe that the possibility of an unwaived breach of covenant or shortfall in liquidity over the three-year period is remote. Under such a scenario the Directors believe that waivers should be obtained from main stakeholders but this is not fully within the Group’s control. Given this, and the material uncertainty highlighted in the going concern assessment, the viability of the business over the three-year assessment period remains uncertain.
Independent auditor’s report to the members of Mitchells & Butlers plc (extract)
2. Material uncertainty related to going concern (extract)
Refer to page 87 (Audit Committee Report), page 121 note 1 (accounting policy and financial disclosures).
We draw attention to note 1 to the financial statements which indicates that the maintenance of growth in sales in the face of pressure on consumer spending power in an environment of falling real wages, and the future outlook for cost inflation across the whole of the cost base but most notably in energy prices, food costs and wages and salaries. The outlook for these is highly uncertain and volatile, particularly energy costs in the second half of FY 2023, and will depend on a number of factors including consumer confidence, global political developments and supply chain disruptions and government policy. These events and conditions, along with the other matters explained in note 1, constitute a material uncertainty that may cast significant doubt on the Group’s and the parent Company’s ability to continue as a going concern.
Our opinion is not modified in respect of this matter.