This pub group’s acquisition of a troubled rival appears to be a smart move. We’ll hold on

Young’s bid for loss-making City Pub Group should pay off as consumers start to feel more confident again

Acquisitions can make or break a business. On the one hand, they can act as a positive catalyst on profits if made at the right price and without weakening the acquirer’s finances. On the other hand, though, history is littered with examples of companies that paid too much for unattractive assets. Some acquisitions, in hindsight, amounted to little more than an ego trip for the bidder’s management team.

Given that British shares are very cheap at the moment, it is unsurprising that acquisitions are taking place. Pub company Young’s, a holding in our Inheritance Tax Portfolio, is the latest to announce a significant purchase.

It plans to acquire City Pub Group, which has 50 predominantly freehold pubs across southern England, in a £162m deal. Three quarters of the sum will be paid in cash and the remainder by the issue of new shares. The purchase has been recommended by City Pub Group’s board, while the owners of around 31pc of its shares have either agreed to the offer or said they intend to. The transaction is expected to complete in the first quarter of next year.

The cash element of the acquisition will be funded by a new £130m loan facility. Given that Young’s had debts equivalent to just 25pc of assets at the time of its interim results in October and that its interest bill was covered more than eight times by profits in the first half of the year, its financial standing should remain sound after the acquisition.

City Pub Group, however, has experienced a challenging recent period. In its most recent financial year, for instance, it made net profits of less than £1m. In its latest half year, meanwhile, it lost around £800,000. Young’s, though, believes it can generate substantial synergies from the deal as staff cuts and greater use of technology boost profits. In addition, 17 of City Pub Group’s freeholds were independently valued at a total of £98m in March 2022.

The timing of the purchase could prove beneficial. Although the pub sector has endured a torrid few years thanks to the pandemic and the cost of living crisis, its future looks more upbeat. Inflation is forecast to fall to less than 2pc within two years, which should provide scope for interest rate cuts and an improving economic outlook. Consumer confidence has already surged in the past year and now stands at an almost two-year high.

Young’s latest half-year results evidenced an improved operating environment. Revenue rose by 5pc, while operating profits increased by almost 7pc, thanks in part to a 0.3 percentage point rise in profit margins. It invested £39m in improving its estate and in making five freehold pub acquisitions, while a further two pubs have been bought since the start of October.

The shares have been perennial underperformers since the start of the pandemic and currently trade 21pc below our notional purchase price from October 2017. Although the sector is clearly not yet booming, it has a more positive outlook than at any point since the first lockdown.

The company therefore remains a worthwhile holding. Its relatively sound financial position, improving profitability and willingness to invest both in its existing estate and in acquisitions mean there are clear catalysts for share price growth. Hold.

Update: Oxford Metrics

Another of our IHT portfolio holdings, Oxford Metrics, has also recently engaged in M&A activity. The motion capture technology specialist announced the purchase of Industrial Vision Systems for just over £8m last month and has said it aims to make further acquisitions.

Its latest annual results, released earlier this month, showed a 54pc rise in revenue and a 79pc increase in earnings per share as it benefited from strong demand. Although its net cash position edged lower, it still stands at around £65m. This suggests it has the financial means to make additional purchases to boost its bottom line.

Even though the company’s shares have risen by just 21pc since their addition to our IHT portfolio in September 2019, they trade at a rather heady 23.7 times earnings, while the recent appointment of a new chief executive to replace a long-time incumbent signals additional risk for investors. But with sound recent financial performance and scope to grow organically and via acquisitions, Oxford Metrics has more room to run. Hold.

‘Young’s believes it can generate substantial synergies as staff cuts and greater use of technology boost profits’