A Value Punt On Pubs

Published in Company Comment on 23 April 2012

Shares in Greene King are almost as cheap as its discounted beers and ales.

After moving to Hampshire in late 2008, I soon sought out my local pub.

Pubs for all punters

What I found was a very pleasant local, with a wide range of beers, a mixed clientele and surprisingly low prices. Thus, for the past three and a half years, I've been a regular drinker at this inn, which is run by leading pub operator Greene King (LSE: GNK).

What has impressed me about my local -- apart from its low prices and cheerful service -- is how it caters to a wide range of visitors. It has cut-price deals for students and regulars (including Greene King's Season Ticket discount card), decent food for diners served until 9pm, and pricier wines and spirits for the more discerning tippler.

Hence, I've been looking over Greene King's shares to see if they offer similar value to my local hostel. Today, GK (as it's known in the pub trade) released a trading update, giving me a chance to get to grips with its latest trading trends.

Going for growth

Greene King runs around 2,400 pubs, restaurants and hotels across Great Britain, via brands such as Hungry Horse, Old English Inns, Loch Fyne Restaurants and Eating Inn. It also brews Greene King IPA (the UK's top cask ale), Old Speckled Hen and Abbot Ale.

In the 50 weeks to 15 April, GK revealed "strong trading," with retail like-for-like sales up 4.5% in the past 13 weeks. Like-for-like food sales were up 6.7% over the same period, with average EBITDA (earnings before interest, tax, depreciation and amortisation) per pub up 3.8% over 48 weeks.

Commenting on these results, chief executive Rooney Anand said: "Our strong trading momentum continued through the final thirteen weeks. March was very strong, helped by the warmer weather, while February was in line with the previous year, despite tough comparatives."

Anand attributes GK's above-average growth to investment in the eating-out market, plus new spring menus launched across its estate before Easter. Also, GK is expanding its estate, with 37 new sites acquired or developed in 2012 so far, taking its Hungry Horse portfolio to 180 sites. The group is also ditching under-performing pubs, with 97 non-core disposals in the year so far.

In the brewing sector, GK's own-brewed volumes were up 0.8% over 50 weeks, versus market shrinkage of 4.5%. This was aided by a £4 million re-launch of Greene King IPA, plus two new ales: Greene King IPA Gold and Greene King IPA Reserve.

Cheap beer, cheap shares?

GK's boss goes on to remark: "Following a record Christmas, we achieved very strong like-for-like sales growth on Valentine's Day, Mother's Day and St Patrick's Day." In addition, Anand is looking forward to more sales boosts from the Queen's Diamond Jubilee, the Euro 2012 football tournament and the London 2012 Olympics.

With 50 pubs a week closing in the UK, GK's performance is mighty impressive. Then again, are its shares as cheap as its beers?

As I write, GK shares trade at 519.5p, up 0.5p on the day. This values the group's equity at over £1.1 billion, making it one of the bigger firms in the mid-cap FTSE 250 index. However, at its latest year-end, GK had more than £1.4 billion of debt. Thus, this high leverage and operational gearing put its shares at higher risk of a debt-related setback.

Then again, GK shares trade on a forward price-to-earnings ratio of 10.1 and offer a prospective dividend yield of an above-average 4.7%, covered a healthy two times. Although its growth isn't expected to shoot out the lights, analysts expect GK's earnings per share to rise by 6% in 2012-13 and 4% in 2013-14, allowing for decent increases to its yearly dividend.

In summary, my view is that value investors and dividend seekers should take a sip of Greene King's shares. If the pub group can increase its operating margins and keep growing its estate at the expense of its competitors, then Greene King shares could rise as easily as a pint of Greene King IPA goes down!

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Illiswilgig 23 Apr 2012 , 6:02pm

Forget a dividend rise, I'd prefer that they put every penny into paying down the debt, then the shares would start a rise that would be hard to stop.

The debt is what stops this share being given the appreciation it deserves,


F958B 23 Apr 2012 , 11:44pm

As above; the last time I looked, GNK's finances were being recklessly managed and the position was precarious.
Last year, operating profit was £222m. Of that, a worrying £85m (38%) was consumed paying their finance costs.
Just a few percent drop in turnover and the dividend disappears.
Several percent drop in turnover and GNK are begging their bankers for mercy.

If the finances were stronger, GNK would be an excellent investment.
As it stands, it's a lot riskier than it first appears.

An ideal candidate for a future value trap if the company doesn't get to grips with the low interest cover.

Probably not a worrying enough financial position to require that investors bail out, but also not attractive enough to buy.

Cisk999 24 Apr 2012 , 1:43pm

F958B - agree with your summary, I looked at GK and compared to Fullers (FSTA) - whilst Fullers were on a higher rating, their debt is much lower (at the last half year op profit was £18.7m and finance costs were £2.4m).

Also Fullers are run very cautiously - backed by a significant family shareholding (£7.3m) and long term commitment.

This is one company where I'd like the price to dip so I can tuck more of these away. I'm surprised they haven't had more of a run due to the Olympics but maybe that will come. Also I travel to the US a bit and find Fullers beer in BevMo in LA - so their export side (from my limited exposure) seems successful.

CunningCliff 24 Apr 2012 , 2:45pm

Yes, I agree, GK's debt is the biggest blot on an otherwise sound investment picture.

Any company with >100% gearing is a lot riskier than the market as a whole.

The big question is whether GK's low PER and high DY are enough to overcome fear of its debt burden?

All the best,


F958B 24 Apr 2012 , 8:39pm

Hi Cliff

I'd rather take my chances with Tesco, despite what another Fool commentator had to say earlier today. ;-)

Compared to GNK, Tesco have:

Lower P/E
Higher dividend yield.
Stronger dividend cover.
Stronger interest cover.
Lower corporate gearing.
More dependabe customer base.
International diversification.

F958B 24 Apr 2012 , 8:49pm

....what about growth? I hear people asking.

Well, maybe Tesco have stalled for now, but, considering GNK's high gearing, and if things go just a little bit wrong for GNK, their gearing (debt) will amplify the downside.

Unless GNK improve their interest cover significantly (say to 3.5x frm current 2.6x) I would not get involved with them.
Of course, the gearing may never bite them in the backside, but, in my experience, it is nearly always high debts which kill companies; usually the final capsize being triggered by a deterioration in trading conditions.
Given the sluggish outlook for the UK economy, with inflation outstripping wage rises and with a difficult jobs market, now seems to be a higher-than-average risk for companies to see difficult trading conditions going forward.
If the economy continues to struggle, I can easily see a drop in sales for pubs and restaurants as people cut back further.

So I reckon that GNK are one of the best candidates of the next five years to be hung by their own rope. That's not to say they will be - but just that they are vulnerable as their finances currently stand.

Hannibalis 25 Apr 2012 , 5:36pm

If you like pubs and have a strong nerve, you could do worse than Enterprise Inns 6.5% 2018 corporate bond - with a 9% yield to maturity (and it was higher).

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