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How will pub law changes hit shares?

by James Dunn

Legislative risk is one of the lesser-known risks that investors face, but they should certainly be aware of it after the 2013 experience of salary packaging, novated leasing provider and fleet management services group McMillan Shakespeare (MMS).

The risks of the unknown unknowns

In July last year, the Rudd government announced proposed changes to fringe benefit tax (FBT) laws, under which McMillan Shakespeare stood to lose more than 30%–40% of its earnings. MMS lost 55% of its market capitalisation on the news.

Not even a change of government and the subsequent reinstatement of the “statutory” FBT calculation method was able to restore fully the lost value.

What most angered McMillan Shakespeare and its fellow car-leasing companies was the lack of consultation – the change was sprung on the industry by the government, out of the blue. Hence the dramatic share price fall.

Investors must always be wary of the potential impact on their portfolios of legislative risk. All sectors of the market have this risk: McMillan Shakespeare and the miners under the ‘super-profit’ tax proposals of the Rudd and Gillard governments have been the highest-profile situations, but it can pop up anywhere at any time.

The latest example of potential legislative risk is a range of measures announced in January by the New South Wales government aimed at decreasing drunken assaults, following a spate of violent incidents on the streets of Sydney.

Amid the package of new offences, sentencing changes and increased police powers were: proposals for 1.30 am lockouts and 3am “last drinks” at bars and clubs across an expanded precinct in the Sydney city centre; a freeze on new liquor licences in New South Wales; and the closure of bottle shops in the state at 10:00 pm.

There are several companies on the stock market exposed to the proposed rules as they stand, and even more exposed if they were emulated by other states.

Bottleshop exposure

Take bottleshops, for example. Woolworths Limited (WOW) owns the BWS and Dan Murphy’s chains and the Woolworths Liquor stores attached to supermarkets. Woolworths is Australia’s largest packaged liquor retailer. It has about 1,250 outlets with more than 350 bottle shops in New South Wales alone.

Coles, owned by Wesfarmers Limited (WES), operates Liquorland, Vintage Cellars and 1st Choice Liquor – with about 785 stores. Woolworths is a bigger player than Coles: analysts say Woolworths generates about twice the liquor revenue of Coles.

Woolworths makes liquor sales of $7.1 billion a year. That is about 18% of the company’s supermarket sales, and about 12% of group sales revenue. Coles does not disclose its liquor sales, but analysts reckon it is about half of Woolworths’ exposure.

Closing bottle shops at 10pm would cause some loss of revenue, but it is very difficult to estimate. One analyst SSR spoke to said that opening times are not uniform: some outlets are currently open after 10pm, and some are not. In the case of Woolworths, said the analyst, how many people buy their liquor requirements earlier – or in bulk – at Dan Murphy’s, as opposed to waiting to buy it after 10 pm at BWS? Given that many will choose the latter course, it’s likely that the O’Farrell laws – even if rolled out nationally – would only curtail a relatively small percentage of sales. My analyst contact estimated it at 2%.

Pubs and clubs

These companies are also exposed to pubs: Coles owns 93 hotels, while Woolworths is a 75% shareholder in the Australian Leisure and Hospitality Group Limited (ALH), which operates 294 hotels in Australia. About 90 of those pubs are owned by Australia Leisure and Entertainment (ALE) Property Group (ASX code: LEP), which is Australia’s largest listed freehold owner of pubs and bottleshops (20 of its pubs also have a Dan Murphy’s outlet attached).

LEP has been a solid performer, earning a total return (including dividends) of 28.7% in the last 12 months; 24% a year over three years; and 19.4% a year over five years. In 2013, Property Investment Research (PIR) named LEP its 2013 A-REIT (Australian real estate investment trust) of the year.

As a way of investing in the pub industry, LEP certainly has appeal – and only 10 of its pubs are located in New South Wales, and none in the CBD. The stock pays a healthy 5.8% yield, with 5.8% forecast in FY15. But currently, the consensus analysts’ price target suggests LEP is over-valued, with the price, at $2.82, sitting 16% above the consensus target, at $2.36.

However, since listing in 2003, ALE has provided a compound annual total return of almost 22% a year: that is not going to be greatly affected if New South Wales bottleshops are forced to close at 10pm.

A far more New South Wales-centric pub exposure is Lantern Hotel Group (LTN), which operates a portfolio of 11 hotels, 10 in New South Wales and one in Cairns, Queensland. Established as part of the restructure of the IEF Real Estate Entertainment Group, Lantern was originally a passive investor in freehold entertainment venues, but was restructured during 2012 to move to an integrated operating model – it owns the land and buildings, holds the licences and operates the hotels.

Lantern has not been a good investment. The stock has returned minus 11.4% in the past 12 months, minus 16.1% a year over three years, and minus 21.4% a year over five years.

The ASX’s other pub investment, the REIT Hotel Property Investments (HPI), is a landlord, with a freehold portfolio of 41 pubs and seven detached bottleshops – these are leased to Coles, owned by Wesfarmers (WES) – and a handful of specialty stores. The bulk of the assets are in Queensland with the rest in South Australia.

Since listing in December 2013, HPI has not set the market on fire: it is currently trading at $2.04, compared to its $2.10 listing price. So while there may be legislative risk in some of these investments, the normal stock and business risk can overwhelm it.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

Published on: Monday, February 10, 2014

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