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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.
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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