Greene King is Britain largest pub retailer and brewer. It has a diverse business which owns pubs, restaurants and hotels. Pubs are by far their biggest division contributing over 80% of total sales.
Despite their size, the company continues to grow at a rapid pace. Like all “heavy-capex” businesses, Greene King acquires more pubs, hotels and restaurant to achieve their SALES GROWTH.
And expansion costs a lot of money.
Greene King Financial Briefs
Over 13 years, revenue grew from £552m to £2,216.50m, an average growth of 11.3%. Meanwhile, net income rose from £52m to £151.7m (though it fell from £190m, last year). Most of this growth came from acquiring Spirit Pub Company for £773.6m.
Looking at the acquired business, Spirit has £800m in sales and £99.4m in net income, according to their 2014’s annual accounts.
Margins and EPS
Size doesn’t matter, I’m interested in profit margins improvement and Earnings per share increases. And the legendary investor agrees with me: –
Well, the chart showed some mixed results with EPS failing to recover back to levels last seen during the great financial crisis. Today’s EPS of 49 pence is lower than the 80 pence produced in 2004.
A similar pattern occurs on its net margin. These data suffer from “one-off” write-downs that skewed operational results.
To avoid this, people should use the net cash margins because it adds back “non-cash” write-down charges. That painted a more streamline pattern.
The relationship between EPS and the share price
Since 2004, Greene King shares outstanding increased from 72.1m to 310m. This wasn’t down to share splits, but a series of equity proceeds. It means shareholders saw limited capital gains. Also, the dividends per share are lower, despite higher dividends paid out.
For example, the pub operator paid out dividends of 33 pence per share in 2004, this is higher than 2016 dividends of 32.05 pence. In absolute terms, dividends paid out rose from £22m to £101m.
Here is a look at a 20-year share price chart of Greene King:
As mentioned earlier, always keep an on the shares outstanding because that will limit, other than that, here are some things to watch out for: –
-An increase in share outstanding doesn’t necessary mean share dilution if it involves a share split;
-Despite, growing net profits, always keep your eye on EPS growth;
-Some companies use debt to grow business, so watch out for leverage;
-Finally, observe the change in margins, especially net cash profit margins.
More analysis on valuation is down below.
Land, Building and Depreciation
Most pub companies own freehold land and building.
For Greene King, this empire building saw the value of their land and building rose from a net value of £933.2m to £3,300.8m.
But, how effectively are they at using their land and building?
Using net profit and net cash profit against values of properties owned.
Like its sales, net profit saw some improvements, while net cash profit generation has fallen.
No surprises that depreciation rate came to 2% because they own their assets. However, Greene King asset write down is a surprise.
Let me explain.
Before the financial crisis, Greene King’s net book values were 90% of original costs.
After the financial crisis, Greene King took a conservative approach and wrote down their assets, as net book values represent 75% to 80% of original costs.
How do you interpret this trend?
First, if commercial properties prices were to fall, Greene King will write-off land and buildings. The value of land and building in proportion to original cost hasn’t changed because depreciation rate remains at 2%.
If you compare the accounting policies from 2004 to 2016, Greene King has said the following: –
“Freehold buildings are depreciated to their estimated residual values over periods up fifty years. Long leasehold properties are depreciated to their estimated residual values over periods up fifty years.”
Secondly, this means the pub operator took a conservative approach by writing down their plant and equipment (i.e. fixtures and fittings).
See chart below for comparison: –
Greene King doesn’t think fixture and fittings play an important role in bringing customers and it’s all about the price of drinks and food.
At the same time, the return on assets is kept by the (ever so slightly) lower asset values. (a couple of hundred million, at best!)
Liquidity, Debt and Operating leases
Earlier, we mentioned that if a pub were to expand they need to take on debt. Has the debt build-up been excessively large or sustainable?
Measuring debt against Land and Building
Debt did rise from £454.1m to £2,517m in 2016. However, the pub’s land and building portfolio cover this debt as properties are valued at £3,300m.
It means total debt represents 65.8% of land and building (plus cash), as this is down from 90% during the financial crisis when buildings prices fell, triggering a slide in the share price of 80%.
What about Debt over Net Income?
Although, excessively in double-digits, it is currently valued at 12.7 times, which is the lowest since 2004.
Again, properties cover debt!
Could it be runaway pension obligations?
Their pension deficit remains steady at £53m, which is down from £60m last year.
Did the purchase of Spirit Pubs caused the shares to fall?
Since making this acquisition it is hard not to link this with the weakness of its share price.
One explanation is the change in the composition of its operating lease. Below you will see the change between Greene King and its operating lease, (Remember, they purchase Spirit Pub in 2015).
Short-term leases obligations
What the above chart tells you is that Greene King is a net receiver of rents, rather than a net payer, until they made the Spirit acquisition.
Now, the roles have reversed, and it is now a net payer of £34m in 2016. One interesting fact investors should watch for is net total operating lease went from £26.1m in 2015 to £1,353.7m in 2016. It means expect to see higher future rental payments.
Greene King’s Cash Generation
With so much debt, you need to know if the business produces enough profits to meet short-term obligations. One way to measure this is by using net operating cash profit (dividing) by current liabilities.
The annual net cash earnings act as a buffer to short-term obligations. They also have a liquidity facility loan (£157.5m) that does this task. From the chart, that buffer has fallen to 32% before recovering to 40%.
Greene King “DODGY” Cash reporting
Since 2014, Greene King included in the cash and cash equivalent something called the Liquidity Facilities loans/reserve and its very purpose is to make debt repayments if there are insufficient funds.
Looking at their notes, it says the facility is REPAYABLE ON DEMAND!!! (see note 8)
It is best to exclude this facility from cash and cash equivalent to get a more accurate reading of the cash balance.
Greene King’s earnings forecast
Although earnings met expectation, earnings for 2018 will come in at adjusted EPS of 72.2 pence, which is a 3% growth from last year. That explains why valuation is low.
Greene King’s Valuation
Given the huge debts in their balance sheet, you need to use “Enterprise Value” rather than market capitalization for valuation purposes.
On a Sales and Asset basis,
Valuation looks fairly cheap.
On a results basis,
Again, valuation looks cheap on a results basis.
So, why aren’t we seeing some love for Greene King share price?
Management has highlighted inflation costs rising meaning that the pub operator needs to reduce costs from within. This could affect services if cuts are affecting morale.
IMO, Greene King like the rest of the service industry is facing inflationary pressures. How long will this last is anyone guess?
Also, adjusted EPS growth of 3% for 2018 isn’t enticing investors to the pub.
An undocumented concern is property prices slowing down after years of growth, this would cause the company to write off property values. The probability of a fall in slim.
Overall, Greene King shares are fairly valued. It is one of the stronger pub brands, given their history. I view this as a dividend income stock, but don’t expect the yield on cost to grow!
A target price of £6.20-£6.30 per share would be a good entry point to invest, however, if financial conditions worsen, it would be best to wait for the economic conditions to improve again.
Checklist for Greene King
-Land and Building values of £3.3bn cover total debt obligation of £2.5bn.
-It has a long history dating back to 1799.
-Net cash generation is strong and currently, stands at £299m.
-Market Valuation is low, compared with the past.
Factors to Watch for
-Property value decline is a major negative for the share price.
-Interest rate rising.
-Inflation and National living wage.
-Too much cost-saving could see customer services lag behind.
-Watch out for total operating leases causing a spike in rental costs.
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The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.
Finally, the writer does not own the company’s stock, unless stated otherwise.