Australia’s biggest pub operator is the crux of a profitability dilemma for its majority owner Woolworths, as the supermarket giant weighs up bottom line and a PR crisis.

Woolworth Limited (ASX: WOW) yesterday announced its full year results for FY16, which included for the first time performance figures for its Endeavour Drinks Group, operating the Dan Murphy’s and BWS brands.

ALH in its current form is largely the product of a chance meeting in 2000 between Bruce Mathieson Sr and then-CEO of WOW, Roger Corbett. This resulted in MGW Hotels, operating 30 Queensland pubs, with a strong focus on securing pub licences in order to take advantage of the State’s law allowing hotel to operate three retail liquor outlets within a 10-kilometre radius of the venue.

This initial operation expanded dramatically in 2004, when WOW and the Mathieson Group paid $1.3 bn to take over the ALH business – the newly listed pub entity emanating from the Foster’s Group exit from pub ownership.

ALH, 75 per cent owned by WOW and 25 per cent by the Mathieson family, expanded again when the Mathiesons brought in around 80 of their own hotels.

The country’s largest pub group now numbers 331 pubs, with around a third in Queensland, chaperoning a total of 560 liquor outlets, 360 of which are in the Sunshine State.

WOW has seen distressing consumer rebuke in the past financial year. Beyond the Masters disaster, the BigW brand lost nearly $15 million and the overall Food & Petrol business is down a whopping 40.8 per cent compared to FY15.

Even the pubs business has felt the heat, dropping 11.1 per cent EBIT to $208.5 million.

One of the few profitable and growing divisions is liquor sales – subject of the company’s new-found “Commitment to greater transparency with Endeavour Drinks Group” – which is inexorably tied to the capital-heavy and slightly image-tainting pubs business.

The Endeavour arm grew EBIT by three per cent to $483.6 million in FY16.

WOW’s latest CEO, the no-nonsense Brad Banducci, has a proclivity for capital efficiency and is leading the charge for company perception overhaul embodied in the “Woolies Welcome” catchcry.

And while ALH has shed many of its freeholds to inadvertently form a distinct class of REIT investor, being landlord to an ALH pub, the businesses still hold around $4bn in capital that WOW would quite like to redeploy elsewhere.

The supermarket giant is believed to be looking at a number of solutions to its dilemma; hamstrung between flailing profits and exposure to liquor and gaming it sees as detrimental to its fading fresh and family-friendly persona.

WOW has experienced considerable flack for an apparent moral conflict between its highly profitable 12,000+ EGMs and its projection as a store ‘for the people’, particularly as ethically-focused investments trend into popularity.

Despite the ALH business having been immensely good to the now rich-listed Mathieson family, its sheer size makes complete ownership unlikely.

There is no shortage of investors interested in a slice of the pie, but a dramatic move by WOW to relinquish its 450,000 shares such as through an IPO could open several Pandora’s boxes, not the least of which being what to do about the Woolworths-secured leases. These have an average remaining term of around 12 years to the likes of ASX-listed entities ALE, HPI and Long WALE, which between them own around half of the 331 pub freeholds.

Although much of the speculation around the future of ALH is merely that, down-played movements behind the scenes hint at the company’s intentions. Bruce Mathieson Jr was recently put in charge of national operations for ALH, stepping up his role as CEO and the family business’s control of day-to-day operations.

Also in May, head of Endeavour Martin Smith was appointed a director of ALH, followed in late June by former WOW CEO Roger Corbett appointed as director and chairman.

Contrastingly, Banducci has broken with the tradition of his two predecessors and opted to not take a place on the board of ALH.

Liquor neon sign.

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