This week’s news of a delay to the final stage of lockdown restrictions lifting will come as a further blow to operators in the hospitality industry who as yet have been unable to open their doors to the public. For the majority that have had the chance to reopen, attention has returned to bolstering trading levels, managing supply chains and tackling staffing challenges.
However, front of mind for all has to be the need to review and repair balance sheets. Operators have used multiple strategies to survive the pandemic and pulled many different levers to help plug the liquidity gap, but many balance sheets are stretched due to the trading liabilities and debt accrued. These over-indebted balance sheets may restrict operators’ ability to grow as fast as they would want to as the market bounces back and final restrictions are hopefully removed in mid-July.
The estimated total of unpaid rent for UK commercial property by June 2021 stands at £7bn alone, whilst the combined total from CBILS and CLBILS stands at c.£27.3bn. With the sector still awaiting fully reopened status, the focus must be delivering on a plan that reduces levels of indebtedness and starts to repair pandemic-related balance sheet damage.
Lenders have been incredibly patient to this point, but operators must demonstrate how they plan to get back to more sustainable debt levels. Clearly articulating this plan will be critical in order to keep lenders onboard and supportive.
The good news is that share prices are back to pre-pandemic levels and we are seeing renewed investor interest in the sector. This interest is being driven by the consistent evidence of pent-up demand, reduced competition and the potential for more advantageous real property deals. There is a breadth and variety of funding sources available, so operators need to identify what they want from any new funding in order to ensure they access the right pocket of capital to return to a sustainable balance sheet position. That new money might be new equity, junior debt, mezzanine - anything other than senior debt, which needs to be reduced to get the balance sheet on to a more stable footing.
Facing into the challenge of deleveraging, we believe businesses should implement as much self-help as they can – ensuring they are maximising opportunities to generate cash and boost profitability. By taking these measures they can both reduce the absolute funding need and increase the debt capacity of the business. Achieving these two goals increases the confidence of securing support from existing funders or securing new money at the lowest possible cost and on the best terms.
Options to generate cash include improving working capital or pursuing selected site disposals, as we have seen from some of the pub groups. Taking a long hard look at where capex is deployed and what opportunities are available to save costs on refurbishments to optimise return on investment will also be helpful.
Operators have been looking hard at their cost base through the pandemic in terms of avoiding costs where possible. As the business reopens, focus will turn to operational efficiency in areas such as staffing, procurement, supply chain and central overheads - the aim being to try to at least maintain margins as business builds back, which will likely require improvements to be made in the face of cost inflation in certain areas. The enforced shutdown has provided opportunities to change ways of working and simplify operations to take cost out.
Understanding what the opportunities are for self-help before engaging with current stakeholders or going into the market to raise new money is important to maximise your chance of success and to secure the best terms.
There also needs to be consideration of what opportunities exist to accelerate growth if more capital is available. It may well be that we are entering a period where the return on investment that can be realised from new sites or refurbishment of existing sites will be outsized because of favourable market conditions in terms of reduced competition and more favourable property terms. What operators don’t want is to miss out because their balance sheet is too stretched. There are genuine prospects to accelerate growth during this period through opportunistic expansion or acquisitions, and this should be part of the conversation with stakeholders.
When we finally do reach the realms of “freedom day”, we expect that the mood music will begin to change and lenders will want to see a clear plan to reduce debt levels. For proactive businesses who implement self-help measures to boost cash and profitability, the presence of significant liquidity in the financing markets means they can secure the support they need and even access funds to support further growth. For those businesses that don’t, there is a risk that the interests of shareholders and lenders diverge and there will be a need for a more fundamental refinancing or even a sale to ensure the lenders are repaid.
This further four-week delay means it’s even more imperative for the hospitality and leisure sector as a whole to get onto the front foot to ensure it is in the best position possible to ride the wave of the unrestricted market recovery when they are able to do so.
An earlier version of this article was previously published in Propel