Greene King is a very old pub operator dating back to 1799. But enough of past, we want to know if this is an investment opportunity investors could exploit.
In this post, I will cover the following: –
-Explaining adjusted EPS and dividend per share;
-How much does freehold properties covers net borrowings, if at all;
-An assessment and the business valuation on Greene King individual divisions.
Is Greene King struggling to grow earnings per share?
Greene King has grown adjusted earnings from £65m to £220m in the past 12 years that saw dividends payments increased from £24m to £100m.
Some new investors would be confused because they see 91.5 pence in 2015 vs. 70.8 pence today, and current dividend per share of 33.2 pence is lower in 2005, as DPS was 36.3 pence. This is because of adjustment made to their share structure, which is given below:
In 2005, Greene King did a share split of 2 to 1.
In 2009, the company did a Rights issue of 80m shares to raise £200m.
All this resulted in share outstanding rising from 72.5m to over 300m.
On an adjusted basis, the long-term investor (invested back in 2005) will see dividends grow from 14.59 pence to 33.2 pence, an increase of 115%.
On a historical level (12 years), the average adjusted EPS is 63 pence and the average DPS is 25.5 pence.
This means the current share price would result in P/E of 8.82 times, and a dividend yield of 4.5%.
Whether it’s historically cheap or not, here is an illustration below:
So, the 12-year average PE is 10.9 times, which makes Greene King undervalued, but not as undervalued back in 2008/09 when PE is below 6!
Greene King Debt Addiction
As well as issuing shares, Greene King has taken on some debt. Although overall total borrowings rose from £1bn to £2.5bn, on a “debt per share” basis, it has fallen from £14 to £8.
That is an improvement.
Then, you also have the share price collapsing from £6.50 to £5.52.
N.B. The period starts from 2005.
Current EBIT yield is over 8%, which is roughly at the historical average of 7.8%. During periods of overvaluation, the yield goes down to 6%, while at peak undervaluation it crosses 11%.
Debt metrics against operational measures
Total net borrowings are roughly £2.1bn.
Debt to equity is stable at around 1.3 times and below their 12-year average of 1.6 times. But, debt to net income spiked to 16 times, which is closer to their historical average.
Generally, pub operators hold valuable assets in their portfolio which helps to negate huge debt build-up.
Greene King holds a lot of freehold land
Greene King has some £3.2bn in freehold properties and properties with over 50 years of leasing in their contracts. By the way, it has £3bn in freehold properties.
Given that net borrowings were recorded at £2.07bn, this gives freehold properties coverage of 1.35 times, leaving shareholders with excess land properties worth £1.1bn.
P.S. Excess land properties = freehold properties minus net borrowings.
The £1.1bn covers 56% of the company’s market capitalisation, which is at their highest level. But the excess land properties are at their second highest level due to Greene King’s market capitalisation declining in value.
More recently, Greene King’s share price has fallen another 22% to £5.56 per share and now cover 64% of market capitalisation.
But we need to accurately measure the value of these freehold properties, and ask: Are they overvalued to bolster Greene King’s assets while increasing their shareholders’ equity? Looking at the net book value of freehold properties against original costs, we get this:
“In 2017, it represents 80% of original costs, which is 10% lower a decade ago. The pub operator decides to adopt a prudent valuation policy because commercial properties value (unlike residential properties value) hasn’t recovered back to levels last seen in 2000.”
Unless Greene King adopts conversion strategies to turn non-profitable pubs into residential properties. That could cost a lot of money, planning consent is required and would only be worth it if properties prices stay at elevated levels.
Greene King’s Market Valuation
With their biggest division seeing L-F-L sales down -1.2% in the 18 weeks to 3rd September 2017, compared to last year 1.4% L-F-L sales growth. So the basis to markdown adjusted profit by 10% for the sake of prudent since no one knows how much adjusted profit will fall.
Also, it is responsible for 75% of group operating profits!
In adjusted profit terms, 2017 saw £219m, so expect it to fall to £198m in 2018.
Next, we move on to valuation.
Market Metrics: The Valuation Verdict
The moment of truth has arrived, is this the time to plough into Greene King’s shares?
To answer this with conviction, we need the following the market valuation, taking into account of the downgrade in profits. Here are the results:
-On an EV/Sales basis, its EV covers sales at 1.75 times, their lowest level and below the historical average of 2.4 times.
-On an EV/Assets basis, its EV covers assets at 0.73 times, another record low.
-On an EV/EBIT basis, its EV covers EBIT at 12.3 times, close to their historical average and translate into an EBIT yield of 8.13%. But their historical low multiple is 9.5 times.
-On a fundamental basis, its earnings power value is currently at £7.93 per share, which represents a 42% undervaluation on the current share price of £5.52. Using EPV, as % of EV, it’s at 118% or showing 18% undervaluation, which is at their highest level. Normally the implied EPV is below Greene King’s enterprise value.
-On a 12-month forward P/E basis, it is forecast at 8.8 times and below their historical average of 11 times. If dividends remain the same, then yield rises from 4.6% to 5.7%. The only time dividend yield is above 6% is during the financial crisis. The historical yield average is 4.1%.
Greene King’s Segment Analysis
The pub operator operates in three divisions, which includes Pub Company, Pub Partners and Brewing and Brands Company.
Their largest division with £1.8bn in sales with an EBIT margin of 17% below their long-term average of 18%. It currently produces after-tax profits of £245m. Net assets are over £3.3bn.
So, a prudent 10 times after-tax profits see their biggest division value at £2.45bn. Assuming L-F-L sales falling by 1.2%, then their after-tax profits could dip to £220m in 2018. Therefore, I lower the multiple slightly to 9.5 times giving it a £2.1bn for next year.
Their highest margin earning division see sales slowly growing to £198m, but produces EBIT margin of 46%, slightly above their long-term average of 44%. It currently produces after-tax profits of £75m.
The problem is they are asset-heavy, where average capex of £26m which takes the shine of free cash flow, also the return on segment assets is below 10%. Finally, net assets come to £846m.
So, a prudent 19 times after-tax profits see their valuation go to £1.425bn. Assuming L-F-L sales rising by 1.4% in 2018, then their after-tax profit is estimated at £82m. I will increase their multiple to 20 times, giving a valuation of £1.64bn in 2018.
Brewing and Brands Company
Their ale brand division sees sales of £200m, but EBIT margins have fallen steadily from 20% to 15% in ten years meaning the business is losing competitiveness. Also, operating profits remain stagnant, despite sales growing by 80%. It currently produces after-tax profits of £24.4m.
Net assets come to over £286.2m.
At best, I will attach 7.5 time multiple on after-tax profits due to weaker and declining margins, this gives it a valuation of £183m.
Assuming L-F-L sales falling by 0.5% in 2018, then their after-tax profits dip to £23.5m. Sticking with the same multiple gives 2018’s valuation of £176.25m.
I am assuming this relates to Headquarters. And it is costing the company £20m in operating profits. Also, it bears net liabilities of £94.8m.
Since this reduces the overall profitability of group you should put a negative multiple of 10 times, plus net liabilities of £94.8m.
Therefore, the corporate segment reduces Greene King to £314.8m.
Segment Analysis: The Conclusion
Remember that Greene King shares dropped 12% (now 15%) since it announces their latest trading update. After crunching the value of each division, you see this change:
Last year results saw Greene King’s division fetch £1.328bn, but a poor trading upside could knock £150m off the value in the business if you assume an overall decline in adjusted earnings by 10%!
Brief Technical Analysis
Looking at Greene King monthly chart, the RSI and MACD indicators are very negative and points to further negativity to the share price.
This negative sentiment could hover for another three or four months before we get further direction. But it also means Greene King’s shares could test £5.
Final Thoughts and Share Price Forecasts
Overall, Greene King is a strong business with strong asset backing. But it is operating at rough times when inflation is rising as wages haven’t kept pace. Households will make a few cutbacks in spending and the first thing that comes to mind is eating out.
The problem is forecasting the longevity of this downturn because further problems could still arise. So, the prudent thing is to wait for a few months.
Now, onto the forecast.
In the next three months, the shares could trend lower towards £5, but don’t be surprised if this drop below £4.50. That could be the perfect opportunity to buy some Greene King shares because EBIT yield would exceed 10%. By the time, we get to the major sports events in 2018, the shares should recover back to £6.50.
Wait three months and see what happens.
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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.