The Investment Column: Happy hour for pub group investors

Xstrata has rich seam to be discovered
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The Independent Online

Do you remember those "pubs call time on happy hour" headlines from a couple of months ago? The British Beer and Pub Association - representing more than half the 59,000 licensed premises in Britain - said its members had agreed to stop cheap drinks promotions to try to tackle the "menace of binge drinking". The Government was delighted, the press was unanimous in its acclaim, praising the pubs industry for its social responsibility.

Hooey. In any other context this would have been condemned as a cartel in action: significant players in an ostensibly competitive industry clubbing together to agree to raise prices.

Such is the furore over binge drinking - of which the sober intervention of the Council of Her Majesty's Circuit Judges yesterday is but the latest example - that everyone appears delighted alcohol prices are on the up. Shareholders in pub companies should be the most delighted of all. After years of vicious competition for business, particularly among high street bar chains led by JD Wetherspoon, which have seen several of the most highly indebted quoted players go bust, price rises are set to become the norm. That should feed through to improved margins.

Is this enough to justify becoming more bullish on the sector as a whole? After all, there are continuing cost pressures, from the rising minimum wage to, most significantly, higher utility bills. The rising price of water and gas will have a disproportionate influence on the pub managers which have the most significant levels of food sales in their mix, Wetherspoon, Greene King and Mitchells & Butlers being the most obvious.

There are also concerns that consumer spending, so buoyant for so long, could be contracting, with fewer people having a large night out on the high street. Wetherspoon looks most vulnerable on this score, since M&B has a greater proportion of local boozers, accounting for about two-thirds of the estate.

This balancing act is important for pubs run directly from head office, in effect all those run by Wetherspoon and M&B, and a substantial minority at Wolverhampton & Dudley Breweries and Greene King. The two biggest pubs groups, Enterprise Inns and Punch Taverns, have a different business model. They lease their pubs to a local landlord, harvesting a predictable rent rather than having to manage the ups and downs of beer and food sales versus wage and energy costs. The stock market has preferred this sort of model in recent years, but an easing of cost pressures in the managed chains could change all that.

So we would search for investments away from Enterprise and Punch, preferring Mitchells & Butlers as a long-term tip. Its strong management track record, and potential upside from new beer supply contracts, stand it in good stead. Wolves & Dudley looks better value than Greene King now the latter's shares have had a good run. And JD Wetherspoon, bizarrely experimenting with early smoking bans and widely written off by analysts, looks a speculative recovery punt as the most highly geared to a reduction in competition.

Xstrata has rich seam to be discovered

Xstrata is one of five mining companies in the FTSE 100, but it does not have the global scale and diversity of assets of the mighty Rio Tinto, Anglo American or BHP Billiton. It does, however, have the ambition to get up there soon.

Since its flotation in 2002, the company has spent £1.4bn to acquire MIM and expand into the explosive-growth market for copper. It also made an unsuccessful tilt at WMC of Australia, which was eventually sold to BHP for £3.8bn.

Mick Davis, the chief executive, is relaxed about having missed out on WMC, saying Xstrata is busying itself with internal projects to mine more ferrochrome and platinum. It will not overpay for an acquisition, and might even step up share buy-backs if it cannot find something soon.

Soaring commodities prices were the main reason for a 73 per cent jump in earnings per share in the first half of the year. The company sees no let up in China's voracious appetite for copper and other commodities, and it will be several years before the industry can get new mining projects on-stream to catch up with demand. In short, prices will stay high.

Finally, thanks to the MIM deal and other programmes across the group, Xstrata is doing more than most to reap cost savings, helping to ease the rampant growth in wage, energy and materials costs.

It is a sound company with a sound strategy, worth buying for the long-term.

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