One 7.7% yielder I'd buy alongside this growth monster
Marstons(LSE: MARS) and City Pub(LSE: CPC) are two fairly similar businesses at different stages in their lives. Marstons is the more mature pub operator with over 1,600 pubs and five breweries. Meanwhile, City Pub operates 34 pubs (as of year-end December 2017).
As one of the largest pub operators in the UK, Marstons' growth is nothing to get excited about. Over the past six years, revenue has risen at a compound annual rate of 6.6%, but costs have increased faster. The group's operating profit margin has declined from 18.7% in 2012 to 17% for 2017. City analysts have pencilled in a 6% decline in earnings per share for 2018, as costs continue to rise following the increase in the minimum wage earlier this month.
In my opinion, City Pub is better placed to weather rising costs due to the nimbleness that usually comes with smaller companies. More prominent businesses like Marstons tend to have bloated cost bases that are difficult to rationalise, but smaller companies typically have a tighter grip on costs and can move faster to offset cost pressures that threaten profit.
Today's results from City Pub go somewhere to affirming this view. For the year to the end of December, the company saw revenue growth of 35% to £37.4m, and adjusted profit before tax jumped 102% to £3.2m, although after excluding the impact of one-off exceptional items, the group reported a loss of £0.7m, down from last year's profit of £0.4m.
Digging into the figures, it seems the bulk of the exceptional costs booked for the period were related to City Pub's IPO last year, which cost £1.9m. There's also a charge of £852k for pub opening costs and £450k charge for the impairment of a pub site. As the business continues to expand, pub opening costs will continue to weigh on profitability. However, expansion costs should be more than offset by the additional profitability these new pubs contribute.
It currently has seven new pubs in development, which will increase the size of its pub portfolio by 20%. City analysts believe these new openings will help the group grow earnings per share to 7.2p by 2018. Management is so optimistic about the future today it has announced a 50% increase in City Pub's dividend to 2.3p.
A price worth paying?
With earnings per share set to grow nearly four-fold between 2016 and 2018, it's no surprise shares in City Pub trade at a high valuation of 22.2 times forward earnings. Still, if the company can achieve the growth analysts are predicting, in my opinion, it deserves this high multiple.
On the other hand, shares in Marstons are more appropriately priced. The stock trades at a forward P/E of 6.9 and supports a dividend yield of 7.7%. The yield is so high because investors seem to be worried about the company's ability to be able to navigate higher costs and falling discretionary incomes. However, so far management has done an excellent job of managing the hostile retail environment, and with the dividend covered twice by earnings per share, it looks as if the payout is here to stay for the time being.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.