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Smart Investor: should you buy your round at Greene King?

Investing can be stressful so time to check out what pub operator Greene King (GNK.L) has to offer.

 
Smart Investor: should you buy your round at Greene King?

As Citywire readers know, investing can be a stressful business. Indeed, when you’ve had a hard day assessing all the risks and rewards, what better way to relax than amble down to the local pub?

Of course, the 'pub' or 'local' is woven into the sinews of British culture. Meeting at the “Mead hall” was an activity brought over by our Nordic ancestors in the 7th and 8th centuries, so it is no surprise that many of the companies operating in today’s brewing sector have a long history.

The 'pub partners' market (landlords to you and me) has been badly hit in recent times by a general move away from the traditional drinking culture, exacerbated by the banning of smoking in public places. These fast-changing social patterns plus government legislation have set up a challenging scenario: the result has been substantial closures of establishments that did not diversify their offer, or were simply in the wrong geographic location.

In this article I take a look at the UK’s largest pub retailer and brewer: FTSE 250 listed Greene King (GNK.L). The firm started life as a brewery in 1799 and over the past 200 years has maintained its brewing antecedents and added a substantial portfolio of traditional pubs. These days it not only operates along the lines of 'pub partners' but also undertakes the management of its own chain of 'gastro pubs' under various brand names such as 'Hungry Horse' and 'Loch Fyne'. A total of 2,500 pubs, restaurants and hotels fall within its remit.

Looking at performance, over the past five years the company has delivered a net profit in each year, albeit a variable one. A low of £40 million in 2009 has improved to £107 million in 2011. During the period, return on equity has averaged around an acceptable 11%, with this level continuing in the latest set of figures.

Meanwhile, dividends have grown slowly. 2011 saw an increase of 7% on the previous year, which is far less than the 33% increase in profits for the same timescale. A pay-out ratio of 47% mitigates this criticism to some extent, with the shares currently yielding 4.5%.

Moving on to free cash flow, the average over the past fi ve years is £70 million versus an average net profit of £92 million. Acquisitions and paying down debt eat into this, with the firm having a substantial amount of goodwill (and debt) on its balance sheet.

Speaking of debt, financial gearing currently stands at 150% using the debt to equity ratio. Over the past five years it is has been heading in the right direction, but still has some way to go before it can be described as comfortable. In addition, interest cover of 2.3 also falls outside the comfort zone, giving the firm only limited headroom should it hit a sticky patch.

As far as an economic moat is concerned, we have seen recently with the upsurge in micro-breweries that it is not especially difficult to enter the brewing industry. However, the pub and restaurant market is perhaps a more challenging sector in which to establish a viable platform, but overall the moat is far from substantial.

So, are the shares good value? At the time of writing they are trading at £5.11, giving a price to book ratio of 1.13 (using net asset value per share of £4.53). However, strip out the goodwill and you are left with tangible net assets of just £1.27 per share. Meanwhile, a price to earnings ratio of 10.3 is encouraging.

Overall, the Greene King investment checklist has both ticks and blanks: performance is improving; dividends are creeping up; return on equity is sufficient, whilst value is acceptable. However, the firm’s interest coverage ratio gives it only a thin cushion for hard times. Additionally, the debt to equity ratio is high, each share comes with a fair chunk of intangible assets, whilst the economic moat is only inches deep.

My aim is to buy quality companies at a fair price. For me, Greene King falls short on viability and performance, which means that I am unable to recommend it as a buy.

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9 comments so far. Why not have your say?

Philmo

May 08, 2012 at 07:21

I'm sure the bar maid pulls a few!

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Twister Spitzer

May 08, 2012 at 10:27

Well written and logical analysis.

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Alexander MOFFATT

May 08, 2012 at 12:07

Greene King are no good for the pub industry - they squeeze their tenants for higher rents when they improve their sales through entrepreneurial hard work. They bleed their tenants dry! Greedy King are accontants and asset stripers, not brewers! Don't buy their shares if you like a friendly local.

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Neil M2

May 08, 2012 at 12:42

I bought some after visiting "The Chestnut Tree" Greene King pub in Andover. Such a nice pub, well run, and busy on a weekday, was enough of a "buy" recommendation for me..

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Hilary hames

May 08, 2012 at 20:46

Interesting. In Investors Chronicle a few weeks ago it was one of their main buys with a whole page devoted to the share.

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Maverick

May 09, 2012 at 15:48

Oh dear oh dear, Neil M2, you're letting your personal preferences rule your judgment. How good one pub is depends a lot more on the character of the landlord than how good the pub owner is.

I go to the hard figures and see that Greene King has risen by 3.3% over the last year and 3.8% from the New Year to date. Not disastrous, but only just beating inflation.

You could have gone into your local Carphone Warehouse shop before last Christmas and found it was staffed by knowledgeable friendly assistants and full of customers. Yet the shares have dropped by 56% since then.

You can't beat the market. You have to follow it. Yes, it annoys me too . . . .

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A C Wiltshire

May 09, 2012 at 17:25

Neil M2 comments on The Chestnut Tree, Andover, are/were true in my experience. I however added the 'were', since the quality of the food ingredients (ie meat and fish) at this Greene King pub have dropped recently in mine and others opinions and prices had risen slightly on our last visit. The pub is still busy, but for how much longer I wonder? My friends and I having decided to give the pub a miss on our next few outings and we are not the only ones if conversations I've had recently are anything to go by. Such a pity, as it is a nice pub, the staff hard working and the food is generally well cooked.

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Neil M2

May 09, 2012 at 20:43

Maverick, A C Wiltshire: I was following advice I had read in a few places such as the Motley Fool, that you should invest in businesses that you personally have positive dealings with.

Don't know whether you would agree with that; I find that myself and my money are easily parted.

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Maverick

May 09, 2012 at 23:44

Neil M2 - Motley Fool and I have never got on. I trust (with a substantial pinch of salt) Investors' Chronicle and The Times, but I trust much more my own monitoring of my watch list. That has figures, not opinions.

Anyone who has worked for a large organisation (as I have) will know that the organisation is just a collection of individuals. Some are good at dealing with the public, some are rubbish. Unfortunately it is impossible to assume that the good ones are the ones running the organisation.

I'm trying very hard to think of a quoted company I've had positive dealings with. The garage at the bottom of my road, yes. Waitrose, yes. The gym I use, yes. All parts of the Goodwood group, yes. None of them are quoted.

But I certainly wouldn't advise buying Greene King shares purely on the basis of the Chestnut Tree in Andover, good though I'm sure it is.

If you're ever down Chichester way, try the Gribble Inn at Oving.

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