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It's easy to open a pub, but it's hard to keep it open – and even harder still to make it an enduring success if it's part of a 'branded pub estate'. Vikki Kunz reports on a sub-sector facing an array of challenges

Britain's pub industry has been transformed since Thatcher's last Government introduced the 'Beer Orders' in 1989, an act which radically reduced the dominance of the national, integrated brewers. As the old empire of this lot declined, that of the independents, both large and small, rose. Within a few years, Britain's high streets were filled with a plethora of newly-formed pub operators, many of which were pushing newfangled brand identities to the UK's keen drinking classes.

That so many new operators adopted a 'brand' approach is none too surprising. After all, a successful brand exudes confidence, quality and enduring appeal – and if you get it right, it also gives you leverage on the prices you can charge (in the words of one marketing executive, 'what does a brand mean? – a 30 per cent mark-up').

The problem, of course, is that a brand, regardless of the industry, needs constant reinvention. Consumers, especially those in the drinking fraternity, are incredibly fickle and if you fail to maintain the kudos of your name – a challenging task on the high street – you're likely to run into trouble as consumers shift swiftly elsewhere.

Growth abounds – but not in brands

Many believe this is what is happening to branded pubs. For instance, the leisure and hotel sector index has followed the UK markets up by 27.3 per cent in the past 12 months, and, according to the British Beer and Pub Association and the Office of National Statistics, the market is growing at two per cent annually, with turnover reaching £28.6 billion in 2003. However, the main beneficiaries aren't the branded pubs but the operators of local 'boozers' and 'community' pubs, singular outlets that often act as the social glue in certain neighbourhoods. Accounting for an estimated 70 per cent of pub revenues, they are most likely to outperform due to high barriers of entry and a typically strong freehold asset backing. Unbranded, yet unique, these outlets are thriving.

Bad timing

If this worries you, look away now, for at a time when their identities are no longer exuding commercial cool, the branded operators are facing the twin troubles of saturation and competition.

'The biggest problem the branded operators face is oversupply,' says Alan Millar, the leisure analyst at broker Arbuthnot. 'The market is already mature, leaving little room for growth. In fact, we could really do with some of the operators exiting the market,' he adds.

Millar readily admits that many of the companies have delayed the roll-out of further branded units but does not believe this is enough. He suspects that some of the smaller operators are in the process of actually deciding whether to continue investment or to sell up and leave the market, taking some pressure off excess supply.

Inventive failings

One company that is definitely suffering from oversupply – and the resultant price discounting that this often provokes – is Inventive Leisure. Operating 38 Revolution vodka bars, the Manchester-based company admitted that in the three months to March, its like-for-like sales were down 10.4 per cent, leaving it to conclude it could no longer avoid price-led promotions and was reviewing its pricing policies for the short term. This caused broker KBC Peel Hunt to downgrade its pre-tax forecast for the year to June by 24 per cent to £2.8 million. The shares have fallen over 47.4 per cent to 63.3p over the year. An EPS of 7.4 provides an undemanding prospective p/e of 8.6, but with little visibility of growth, the stock is unlikely to rise in the near future.

Sell-by dates approaching

Another company having problems retaining its brand appeal is Yates, the bar and restaurant operator. Appearing on high streets in virtually every major town, Yates' 129 outlets target the discount end of the market. Formerly operating under the Yates Wine Lodge brand, Yates had to revamp its dated image concept after losing customer appeal, which led to profit warnings in 2003.

Despite its other brand, the food-led Ha! Ha! Canteen performing well, pre-tax profits to March fell 58 per cent to £4.1 million. House broker Arbuthnot expects this to improve in 2005 to £11 million (on an adjusted level) but Yates' days as a stock market player seem numbered following a 'recommended' 147p bid for the company by Thorium (a consortium which comprises the management team of Yates and private equity group GI Partners). At present, this offer has 53.9 per cent acceptances.

Another recognising the need to update a tired brand is brewing, hotels and pub outfit Fuller, Smith & Turner. It moved tentatively into the branded world (its usual stomping ground is traditional corner pubs serving its own ales) with The Fine Line, of which it opened eight units throughout central London. However, in the year to March, like-for-like sales at its managed pubs in London fell five per cent.

Sheila McKensie, a consultant at Fuller, says the company recognised the bars had a 'tired look' and it is now in the process of refurbishing each unit. Removing the 'cool' effect of pale fittings effects, McKensie believes customers want to be surrounded by warmer tones, such as chocolate brown. That's all very well, but each refit is expected to cost on average £160,00 – hardly small beer.

Happily, The Fine Line only comprises a small portion of the entire estate of 238 pubs, bars and hotels, and the wider Fuller operation remains a steady if unspectacular player. At the pre-tax line, the market is expecting profits of £18.1 million (£17 million) on an improved turnover of £148 million (£140.3 million) this year.

Unsurprisingly, Fuller has no intention of developing any further brands, preferring to expand its hotel offering instead.

A bright light

One company that appears to have successfully mastered the dark brand arts is bar/nightclub group Urbium. Although it has over 20 nightclubs and 'style' bars in London, it is best known for its Tiger Tiger concept. With eight larger units, the brand is doing so well that it is one of the few companies that is continuing its brand expansion by rolling out a smaller Tiger Tiger format in secondary towns, the first opening in Aberdeen in June.

'We never compromise our brand values in order to chase greater short-term profits,' proclaims Urbium's chairman John Conlan. The group, which reported pre-tax profits of £9.3 million in 2003 and is expected to increase this to £11 million in 2004, holds a niche position in the affluent 25-40 year-old market.

It also operates a multi-room arrangement, with a restaurant, bar and nightclub area, enabling it to attract customers for lunch, early evening drinks and partying late at night. 'We realise the challenge is to keep the brand fresh and so we innovate and renovate constantly,' says Conlan. The health of the brand is so robust, that its Haymarket venue reported its best profits in its fifth year of operation. The shares are trading at 540p a share, and Urbium's forward p/e of 7.8 is modest compared to the sector average of 16.9.

Too much, too fast

Urbium's studied and patient approach to growth contrasts sharply with an unlucky few who have expanded their operations too fast, too soon and with the wrong kind of finance.

Regent Inns is a perfect example of this ilk. Operating Aussie-themed nightclub Walkabout as well as Bar Risa/Jongleurs, it grew swiftly, and was initially something of a stock market darling before poor trading results ruined the love-in.

Most of the problems stem from the Walkabout outlets, which are suffering from price discounting by competitors and are also losing out on early-week business – especially amongst the previously loyal youth and student population.

Regent's finance director Simon Rowe states the company is implementing new drives, such as Friday 'Big Brother' eviction nights, to attract its customers back and 'place itself above the parapet'. However, it is illuminating that Rowe confirmed Regent will not be opening any new venues for a couple of years and that it has suspended further development of its new Stonehouse food-led concept.

Although broker Arbuthnot still expects it to make a profit in 2004 of £12 million (£14.4 milion), its debt is worrying. In November, when it placed 21.7 million shares, raising £18 million, speculation was rife that its banks forced the placement to reduce gearing from 150 per cent. For the year to June just passed, gearing is expected to have fallen to 117 per cent, but many analysts remain wary.

Luminar is suffering from many of the same issues. It aggressively expanded its Chicago Rock Café formula in the 1980s and now operates 340 units, including other brands such as Jumpin' Jacks, Liquid and Oceana that predominantly focus on the late-night entertainment market. Pricing competition and oversupply has caused the company to lose market share in early-week trade. For the year to February, pre-tax profits before goodwill amortisation, exceptional items and taxation came in at £62 million compared to £67 million in 2003.

Unlike Regent, however, Luminar has a fairly robust balance sheet and generates a lot of cash – £46 million was produced in the year to February and gearing remains at a comfortable 40 per cent.

But operating margins are falling (they dipped from 20.2 per cent to 19.4 per cent during this period) and the downward trend looks likely to continue into 2004 – like-for-like sales to the end of June were four per cent down. In an interesting departure, it is looking towards gaming opportunities in time for UK gambling law changes.

Freeholds mean more than brands

Ultimate Leisure's management would probably argue that what has sustained growth at their company has been the unique multi-brand approach they have adopted (its offerings include Chase bars, Beach nightclubs and the rodeo-themed Coyote Wild). This buoyant team, led by chief executive Allan Rankin, recently reported that its results for the year to June will be at the top end of market expectations with sales 35 per cent higher than the previous year. Forecasts for 2004 suggest sales will rise to £35 million with pre-tax profits jumping 31 per cent to £8.8 million (and on to £11.5 million in 2005).

Interestingly, Ultimate's growth strategy has been based around actually purchasing the freehold properties of the clubs it opens. This makes it commercially investigate the areas it operates in more deeply than rivals, provides asset-backing and shields it from expensive (and inflationary) rents. Should any new unit fail to measure up in trading terms, the underlying asset can simply be sold.

The company's finances are strong after a placing in October raised £20 million to reduce gearing from 86 per cent to 15 per cent. The prospective p/e of 10.7 is not a bargain, but long-term prospects look good.