After two years of lacklustre performance ending with a shallow recession in H2 2023, the UK economy was at last generating some positive news during the first six months of 2024, before the October Budget and its unprecedented peacetime tax-raising agenda seems to have severely shaken the business community.
The Institute of Directors has just published its Economic Confidence Index for November 2024, which shows that confidence among business leaders has fallen sharply by 25% in November to a figure of -65 and is now close to its record low in April 2020 (-69) at the onset of the Covid pandemic. This is the second lowest reading of the Index since it began in July 2016.
After struggling through the pandemic, the worst of surging cost inflation, sharply higher interest rates and the impact of the cost of living crisis on their customers’ disposable incomes, hospitality businesses are facing a huge challenge in how they respond to the October Budget cost increases.
Media comment on the sector continues to be dominated by stories of businesses of all types, shapes and sizes struggling with disappearing profit margins, ever-rising costs and ongoing labour shortages. Recent high profile closures of iconic restaurants include The Grand Duchess and the Prince Regent floating venues on the Regent’s Canal in Paddington and Launceston Place in Kensington. Further afield, Kino has closed in Leeds after less than three years.
To see how this public perception fits with financial reality, we have analysed the latest published accounts of every pub, club and restaurant company in the UK for the fifth time in the past three years. Unfortunately, this research confirms that the sector’s finances continue to head south, with significant deterioration in all the key risk ratios in the past fifteen months.
The one positive development has been a major reduction in debt levels, although this has been accompanied by a noticeable shrinking in the overall size of the sector as measured by total assets and net worth. This either reflects losses eating away at hospitality balance sheets or a worrying reduction in the ongoing investments that hospitality businesses have to make to stay attractive to their customers.
We remain frustrated by the long delay allowed for filing accounts at Companies House, which means that at any point in time, accounting information in the public domain is between nine and eighteen months out of date. As such, we suspect that when we next carry out this analysis in six months’ time, the financial profile of hospitality is likely to be even more troubling.
Market Characteristics
The hospitality sector accounts for 3% of the UK’s GDP or some £71bn in gross added value when accommodation output of £25bn is added to the activities of pubs, clubs and restaurants. This remains well below the pre-pandemic output of £104bn. It employed 3.2m people or 10% of the workforce before the pandemic, but this has fallen now to 2.5m. Our research shows that excluding accommodation-only businesses, it now deploys £50bn of assets, borrows £12bn and has an overall net worth of £13bn.
Research by Alix Partners in October 2024 shows that the UK’s number of licensed premises increased by 0.7% between July and September 2024 – equivalent to 661 net new openings, or 7 per day. With a current total of 99,868 licensed premises, the market is now back to almost exactly where it was at this time in 2023, tantalisingly close to the milestone of 100,000 sites that the sector fell below earlier this year.
The best news comes from the independent part of the hospitality market. Small businesses have borne the brunt of the pandemic, rampant cost inflation and the cost of living crisis, which have combined to shrink the indie segment by 16% since March 2020. However, after contracting every quarter for four years, it has now been expanding for two in a row. Site numbers increased by 447 in the three months to September 2024, which is just over 5 net openings every day.
Financial Risk Profile
There are currently 85,489 companies registered at Companies House, whose business is recorded as running pubs, clubs or restaurants. We analysed their finances using the data analytical system at Company Watch, the financial health monitoring specialists. A summary of our research can be found here.
Overall Financial Health Score
Our analysis of the sector’s finances reveals that the average financial health rating (H-Score®) awarded by the Company Watch system is only 31 out of a maximum of 100, compared to the whole economy where an average closer to 48 would be expected. Worryingly, this is down from 35 out of 100 in August 2022 and 33 in September 2023.
Vulnerable Companies
Over half of all hospitality companies (53% or 45,316) are in the Company Watch warning area with an H-Score of 25 or less. Historically going back more than twenty years, such a low level of H-Score indicates that one in four of these vulnerable entities will file for insolvency or have to undergo a significant financial restructuring during the next three years. This is significantly worse than in September 2023, when only 47% (40,238) were in the warning area.
Zombie Companies
One in five (17,477) hospitality companies had negative balance sheets (of at least a de minimis figure of £20k). This is a deterioration since September 2023, when 19% (15,739) were zombies. Their overall combined deficits continue to climb. This time, their shortfalls add up to £2.4bn compared to £2bn in September 2023.
Negative Working Capital
Another very worrying finding is that 23,350 (27%) of the companies have negative working capital of at least £20k. This means that their short term liabilities due for payment in less than a year exceed their ‘quick’, easily realisable assets such as receivables, inventory and cash. This compares unfavourably with 19,893 (23%) with negative working capital in September 2023.
The overall working capital shortfall of these companies shows an even more alarming deterioration. It has shot up to £7.4bn from £4.9bn in September 2023. A deficit position on working capital represents a vulnerable financial profile, so by any judgment this is an undesirable and risky financial model at such a challenging time for the industry.
Smaller hospitality businesses
Our analysis also confirmed how fragmented the industry is and how fragile some parts of it are, with 28,529 (33%) companies having total assets of less than £25,000. With financial fragility comes much greater risk. 62% of these micro businesses are in the Company Watch warning area and their average financial health rating is only 26 out of a maximum of 100. This is a clear deterioration from the 59% in the warning area and an average H-Score of 27 in September 2023.
Business failures
According to the latest Insolvency Service statistics, there were 3,768 failures of pubs, clubs and restaurants in England & Wales in the twelve months to November 2024, equal to 15% of all failures. This is a sharp increase from as recently as 2022, when this percentage was only 11%. Only the construction sector has a higher percentage of insolvencies at 17%.
It is highly likely that this adverse trend will continue and probably worsen, given the extreme difficulties the industry is facing from April 2025 over the October Budget cost increases for Employers’ National Insurance, the National Minimum Wage and Business Rates
Debt levels
The overall borrowings of the industry have fallen dramatically by 26% to £12.2bn since September 2023. The average borrowings per hospitality company are £142,503 compared to £194,246 only fifteen months ago. The one slight concern is that the debt reduction for the smallest hospitality companies is lower, but it is still some welcome.
Staffing issues
Recruitment and retention of staff remain major issues for many hospitality businesses, with staff shortages often restricting opening hours. This produces a knock-on effect on the quality of service experience that restaurants in particular can give their customers, which is unfortunate at a time when menu prices have already increased to recover at least some of the rampant cost increases of the past two years and will likely have to do so again as the Budget measures hit next April.
According to figures from the Office for National Statistics published in September 2024, vacancies in the sector have finally come down below the key level of 100,000 and within 5,000 of the pre-pandemic level of 93k in the three months to February 2020. Despite this reduction, any suggestion that vacancies are anywhere near as easy to fill now as they were in early 2020 would be well wide of the mark.
The October Budget
The immediate reaction of the hospitality industry to the Budget was summed up by UKHospitality CEO, Kate Nicholls:
“This Budget is the latest blow for hospitality businesses. Rising taxes, increasing costs and fragile consumer confidence risk bringing growth to a grinding halt.”
She estimates that the additional costs imposed on hospitality businesses from next April will be £3bn a year.
The only positive for the sector was the Chancellor’s announcement that from 2026/27, there will be a permanently lower level of business rates for hospitality. Despite this, the reduction of the business rates discount for retail, hospitality and leisure firms in England from 75% to 40% for the 2025/26 financial year will mean an average 140% rise in business rates bills for more than 250,000 high street premises in England from next April. According to commercial real estate intelligence firm Altus, the average business rates bill for pubs will increase from £3,938 to £9451. Restaurants will see their average bill rising from £5,051 to £12,122.
Employment rights changes
The government has announced its intention to introduce major changes to employment rights during the current Parliament, subject to a consultation period expected to take up to two years. These changes will include measures impacting two aspects fundamental to many hospitality businesses: zero-hour contracts and notice of shifts. The UKHospitality Deputy CEO, Allen Simpson expressed his concerns to a recent hearing of Parliament’s Employment Rights Committee.
What are the prospects for UK hospitality businesses?
The impact of the extra costs imposed by the recent Budget and how the hospitality sector reacts and adapts to them overshadow all other factors which might otherwise determine the short and medium term outlook.
How far hospitality businesses can absorb the increasing tax burden, whilst still investing and creating jobs, remains to be seen. The immediate reaction from industry leaders to the Budget has been one of total disappointment and frustration, to the point of disbelief. Counter to this, there is the possibility that the rise in the National Living Wage might persuade customers to spend more.
The hope must be that the Budget will not derail entirely the improvement in the sector shown by the latest Alix Partners Hospitality Monitor. The current festive season trading will be vital in providing pubs, clubs and restaurants with sufficient fat to get through the lean post-Christmas period and then to weather the Budget cost storm from next April onwards.
In this regard, CGA RSM Tracker of UK pub and restaurant sales for November is mildly encouraging, showing that overall like-for-like sales across the 115 leading companies it surveyed were 2.7% up compared to November 2023. The accompanying press release commented:
“November’s results represent a welcome rebound in spending after consumer confidence took a hit in the run up to October’s Autumn Budget, with like-for-like growth the highest since June and above the average for the 2024 year so far.”
Beyond the key Christmas period, which businesses will survive and thrive and which will fall by the wayside because of the Budget will depend not just on how robust their finances are, but crucially also on the reaction of customers to any extra costs they pass on through increased prices and their ability to maintain acceptable service standards and customer satisfaction levels if they opt to reduce staffing to compensate.
To call this challenging would be a major understatement, especially against the background of the fragile and deteriorating financial profile revealed by our research.
If you would like to discuss any of the points in the report or believe you have been affected by any of these issues, you can speak to one of our Partners who can discuss options with you.
We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team, who can discuss options with you.