The UK Hospitality Market – Will the pandemic ever end?
Hospitality market conditions in the Pandemic
The hospitality market; probably the only industry to suffer more disruption from Coronavirus than the UK’s pubs, clubs and restaurants has been the travel sector. Lockdowns, endless varying restrictions, the WFH phenomenon and biosecurity considerations have caused havoc, slashing revenues and driving up overhead costs.
Rampant inflation is now savaging profitability, with soaring input costs for energy and direct costs like food and alcohol. At the same time, the combined impact of the pandemic and Brexit have reduced the sector’s workforce to the point where normal operations are under constant threat, whilst ratcheting up labour rates for those staff who can be retained or recruited.
The very latest bolt from the biosecurity blue is the Omicron variant, prompting wholesale cancellations of bookings for the vital festive season in the face of uncertainty about its transmissibility, the risk that vaccines may be less effective, the government’s Plan B restrictions and most recently the panic-button ‘You Must Get Boosted’ campaign.
Unfortunately, the Treasury’s £1bn support package announced three weeks into the Omicron crisis and just four days before Christmas will do little to rescue struggling hospitality businesses and their staff. Some smaller pubs and restaurants will only get £2,700, which will be less than the takings they lost over the final weekend before the festive break and certainly below the damage that the variant will also do their Christmas Day lunch trade.
Market characteristics
This is an industry that creates 5% of the UK’s GDP or some £85bn in gross added value when accommodation spend is added to the activities of pubs, clubs and restaurants. It employed 3.2m people or 10% of the workforce before the pandemic, but certainly fewer now. It deploys £32bn of assets, borrows £13.3bn and have an overall net worth of £6.7bn.
Research published by Alix Partners shows that almost 1,000 hospitality sites closed in the two months up to September 2021 (a rate of 16 per day), leaving the industry with 9,900 fewer sites than before the pandemic struck. Smaller businesses bore the brunt of the latest shrinkage, accounting for almost 75% of the closures.
Financial risks
Even with the robust pre-crisis level of activity, the industry did not enter the pandemic in the best of financial health. Research using the data analytics system operated by the financial health monitoring specialists, Company Watch reveals some worrying signs of financial strain and distress. The picture will surely worsen still further over the next few months as companies file more accounts showing their trading for the period of disruption since March 2020.
There are 72,474 companies registered at Companies House, whose business is to run pubs, clubs or restaurants. Of these, half (36,368) are in the Company Watch warning area, indicating that one in four of these vulnerable entities will file for insolvency or undergo a significant financial restructuring during the next three years based on an analysis of their latest published accounts.
Mercifully, insolvencies in the sector have been limited because of the various government support measures, in particular the furlough scheme and the ban on creditors issuing Winding Up petitions or landlords enforcing rent arrears. There were 1,167 failures in the first nine months of 2021. Sadly, after the unprecedented financial disturbance caused by Coronavirus, it cannot be assumed that this trend will continue, particularly now that most government support has been withdrawn. The Company Watch warning area statistics suggest that the hospitality failure rate could double next year and beyond.
The average financial health score awarded by the Company Watch system (H-Score®) is only 32 out of a maximum of 100, compared to the whole economy where an average closer to 50% would be expected. 19,131 (26%) of hospitality companies had negative balance sheets with a combined deficit for these ‘zombies’ of £1.bn. Our analysis also confirmed how fragmented the industry is and how fragile some parts of it are, with 22,788 (31%) companies having total assets of £25,000 or less.
Soaring debt levels
We focused particularly on the changes in debt levels in our research through Company Watch, mindful of widely-held concerns at the scale of borrowing under the government guaranteed loan schemes introduced at the start of the pandemic. Total loans across the whole economy made under these schemes were £76bn and a third of all UK businesses are said to have taken on more debt as a result. We compared debt levels at April 2021 with the current position in December 2021, just eight months later.
To identify where the greatest debt strain might be in the hospitality sector, we analysed debt levels according to the size of hospitality businesses, ranking them according to their total assets. The results for smaller businesses are particularly worrying. Companies with assets between £100k and £250k have seen their debt levels rise by 60% in just eight months, but for those with assets of less £100k have more than doubled in that time, increasing by 108%.
These are the least robust businesses in the sector with only modest assets to support this surging borrowing and the most fragile profitability and cash flow to pay back the interest and the debt itself.
Pandemic legacy liabilities
It is not just extra borrowing stressing hospitality balance sheets and cash flow. Other unpaid liabilities have been building up. No landlord has been able to enforce unpaid rent since March 2020 and will not be able to until at least March 2022, but these arrears have not gone away. They will still need repaying unless a deal can be done with the landlord.
VAT and PAYE collection was suspended for much of the pandemic, but now HMRC is back on the case, looking to reduce the huge build up of £42bn of tax arrears. Their stated aim is to cut this to £33bn by April 2022. That reduction will all have to come out of current cash flow or yet more debt.
Post-pandemic dangers
Experience of previous recessions teaches us that the factor that kills more companies is not the financial crisis itself, but uncontrolled growth once it is over. Firms find it difficult to resist taking on more business and expanding, but too often leave it too late to raise the additional working capital needed to fund the increased activity.
Getting match fit ready
Hospitality has had two terrible years and is heading into 2022 plagued by yet more uncertainty, this time over Omicron. Our research shows the early signs of the damage to financial viability caused by the pandemic, but the true picture is inevitably worse. Balance sheets have been loaded with borrowings and unpaid legacy liabilities abound, while getting businesses and their staff back to the required level of operational efficiency is going to be a major challenge even when there are no restrictions once again and customers feel confident in returning to their old eating and drinking habits.
In any case, some aspects of hospitality may changed for ever, either because of the WFH phenomenon or evolving customer preferences. Labour shortages are here to stay and cheap pay rates are a thing of the past. High input cost inflation looks more and more likely to be long term, not transitory. Disposable income to meet hospitality spending will be severely squeezed in 2022 and beyond.
It is imperative that owners and managers focus now on sorting out as many financial and practical issues as soon as possible and as fast as circumstances allow.
A thorough refurbishment and recovery programme is required:
- Realistic cash flow and profit forecasts need preparing, based on reasonable assumptions
- Finances need restructuring
- Debts and legacy pandemic liabilities need re-negotiating
- Working capital resources need bolstering to support growth in 2022 and beyond
- Staff retention must be a key priority
- Operational capacity and configurations need re-aligning with the new normal, whatever that finally turns out to be
- Operating costs and fixed overheads need reducing
Going forward
Hospitality is far from being out of the woods, indeed it is now in a whole new, dense thicket with Omicron. The desperately-needed fat of a healthy festive season has been snatched away, leaving too many pubs, clubs and restaurants facing the lean months until Spring with the barest of financial bones. Getting through this will mean yet more change, the acceptance of new commercial realities and taking some very difficult decisions.
Getting the earliest possible independent expert advice from turnaround and restructuring professionals will be a vital part of that process.
Not only are whole swathes of hospitality managers and staff shell-shocked from what they have been through, but very few executives have the necessary experience of these recovery situations to choose the right options and implement the tough actions that are now both essential and urgent.
Help is out there, it must not be ignored.
December 2021
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