Despite some isolated positive indicators, the UK economy is bumping along the bottom and economic pundits are suddenly queueing up to predict a recession later this year and in 2024.
The relationship between CPI inflation and earnings growth is a key factor for the hospitality industry, governing how much money consumers have for discretionary spending, such as eating and drinking out. August finally saw a positive number published by the Office for National Statistics, which confirmed that for the first time since October 2021 wages are rising faster than prices. In the three months to July 2023, average weekly earnings for total pay in the United Kingdom grew by 8.5%, while CPI inflation that month was only 6.8%.
Nevertheless, anecdotal comment on the sector remains dominated by tales of businesses struggling with falling profit margins, rising costs, labour shortages and adverse changes in customer behaviour.
To see how this rhetoric matches up to financial reality, we have analysed the latest published accounts of every pub, club and restaurant company in the UK for the fourth time in just over two years. Unfortunately, this research confirms that the upward trend we found in August 2022 has been reversed to the extent the overall financial health of the sector is now back down to the levels last seen in the dark days at the end of the pandemic in December 2021.
Within this bigger picture, there are some positives, with reduced debt levels for all but the smallest businesses and fewer of both ‘zombie’ companies with negative balance sheets and those with negative working capital.
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which means that at any point in time, accounting information in the public domain is between nine and eighteen months out of date.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, the financial profile of hospitality is likely to be still darker and more troubling.
Market Characteristics
This is an industry that creates of 4% of the UK’s GDP or some £74bn 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 this has fallen now to 2.6m. Our research shows that excluding accommodation businesses, it now deploys £37bn of assets, borrows £12bn and has an overall net worth of £10.8bn.
Research published in July 2023 by Alix Partners shows after stabilising in mid-2022, the hospitality market has shrunk by 5.4% (16 premises a day) in the year to June 2023 when measured by the number of licensed premises, of which there remained only 100,176. The prediction is that this total will almost certainly fall below the 100,000 mark by the end of 2023 for the first time since records began.
The worst hit sub-sectors have been casual dining (down 5.6%), sports and social bars (down 6.5%) and nightclubs (down 12.2%). The winners beating the average trend have been food-led pubs (down 2.9%), high street pubs (down 3.1%) and community pubs (down 4.1%). There has been a loss of 14,932 (13%) sites since before the pandemic, of which 77% were smaller, independent businesses.
Financial Risk
There are currently 84,843 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 score awarded by the Company Watch system (H-Score®) is only 33 out of a maximum of 100, compared to the whole economy where an average closer to 50 would be expected. Worryingly, this is down from 35 out of 100 in August 2022.
Vulnerable Companies
Some 47% (40,238) are in the Company Watch warning area with an H-Score of 25 or less. Historically going back some twenty years, this low level of H-Score indicates 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. This is significantly worse than in August 2022, when only 44% (34,458) were in the warning area
Zombie Companies
One in five (15,739) hospitality companies had negative balance sheets (of at least a de minimis figure of £20k). This is an improvement since August 2022 in terms of the percentage of companies, which was 25% then, but not when measured by their combined deficits. Despite the fall in the number of zombies, their overall deficit has risen from £1.9bn in August 2022 to £2bn now.
Negative Working Capital
Another very worrying finding is that 19,893 (23%) 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. While the number and percentage with negative working capital have both fallen since August 2022 (when there were 21,877 companies, or 28% of the total), the overall working capital deficit has grown from £4.3bn in August 2022 to £4.9bn now. By any judgment, this is an undesirable and risky financial model in such uncertain times.
Smaller hospitality businesses
Our analysis also confirmed how fragmented the industry is and how fragile some parts of it are, with 26,464 (31%) companies having total assets of less than £25,000. With financial fragility comes much greater risk. 59% of these micro businesses are in the Company Watch warning area and their average financial health rating is only 27 out of a maximum of 100. This is a marked deterioration from the 55% in the warning area and an average H-Score of 29 in August 2022.
Business failures
During the pandemic period, insolvencies in the sector were limited by various government support measures, in particular the furlough scheme and the ban on creditors issuing Winding Up petitions or landlords enforcing rent arrears. According to Insolvency Service statistics, there were 1,411 failures of pubs, clubs and restaurants in England, Scotland & Wales in the first seven months of 2022 which represented 11% of all corporate insolvencies.
There has been a clear acceleration of hospitality insolvencies this year. The first seven months of 2023 saw 2,182 failures, equal to 15% of all failures, a sharp deterioration. It is highly likely that this trend will continue and probably worsen, given the extreme difficulties facing the industry over the cost of living crisis, rising input costs for materials and labour and the lack of any protection against savagely higher energy costs. For those businesses with debt, there are also higher interest costs to deal with.
Rising debt levels in smaller hospitality businesses
The overall borrowings of the industry have fallen significantly, dropping from £12.9bn in August 2022 to £10.8bn now. Looking at average debt per company, the situation has improved for all sizes of hospitality business, except the very smallest:
- Assets of £250k or more – average debt down from £1.3m to £901k
- Assets between £100k and £249k – average debt down from £17.5k to £14.4k
- Assets between £25k and £99k – average debt down from £8.2k to £6.6k
- Micro entities with assets of less than £25k – average debt up from £1.7k to £1.8k
Despite these reductions, debt levels are up on pre-pandemic levels for smaller companies as follows:
- Assets between £100k and £249k – up 37%
- Assets between £25k and £99k – 2 times higher
- Micro entities with assets of less than £25k – 3 times higher
Business Rates
The perennial elephant in the pub snug is the sheer unfairness of the business rates burden faced by many business sectors, but especially hospitality. The September inflation figure will determine the rise in business rates next April, so many fingers are crossed hoping for a significant drop, though this seems unlikely with surging oil prices pushing up fuel costs. UK Hospitality has warned that with previous relief schemes ending, the outcome could be a catastrophic extra £1bn bill for hospitality businesses.
What now for the UK’s hospitality sector?
It is still hard to underplay the magnitude of the challenges facing hospitality businesses. They touch and potentially damage all parts of their finances and operations, from top line revenue, through gross margins, overheads and debt service costs and then onto trading capacity curtailed and customer experience damaged by labour shortages.
There are no simple solutions to a commercial conundrum of this complexity. The only way forward is for hospitality to provide the best standards to customers it can, despite the extreme difficulties it faces, and to adapt its offerings to the issues facing those customers and their changing needs.
The survivors and winners in hospitality will be those which are efficient, know and relate to their customer base well and have both sound finances and nimble-footed management. That said, it’s doubtful whether the forthcoming festive season has ever been more important. Getting that right is going to be imperative.
If a hospitality business doesn’t tick all of those boxes, then it would be wise to call in expert advisors and do it without delay. These are seriously stormy waters, so it’s best having a navigator aboard who knows where the rocks are and when to trim the sails to make a run for a safe harbour.
September 2023
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.