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Greene King - Gathering headwinds leave a hangover

Nicholas Hyett | 30 November 2017 | A A A
Greene King - Gathering headwinds leave a hangover

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Greene King Ord 12.5p

Sell: 849.30 | Buy: 849.30 | Change 0.10 (0.01%)
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Revenues of £1bn were down 1.2% in the first half following weakness in Greene King's managed estate. Cost headwinds squeezed margins, with underlying operating profits down 7.5% to £188.4m. The interim dividend remains unchanged at 8.8p.

The shares fell 8% in early trading.

Our View

Greene King has a great track record of dividend growth. Since CEO Rooney Anand took the reins in 2005, turnover and dividends per share have doubled. Indeed, strip out the impact of a tax-related rescheduling of dividends in 2008/09 and the payout has grown every year for more than two decades.

However, things are looking a bit tough at the moment. The squeeze on real wages is hitting demand, while the explosion in new places to eat means competition for a share of the public's purse has rarely been higher. Add in a whole raft of cost headwinds and a sizeable debt pile, and things aren't looking quite as secure as they once did.

In response, Greene King has upped investment in the estate, cut prices and increased marketing spend. Early signs suggests these efforts are delivering results for the top line, but on the impact on margins means profits are falling.

On the positive side, the group has a sterling track record when it comes to taking costs out of the business. Brand consolidation, in a portfolio that stretches from Hungry Horse and Flaming Grill to Loch Fyne and Wacky Warehouse, should help boost returns from underperforming pubs. Those self-help measures could be crucial to weathering the growing storm.

Greene King's track record deserves recognition, and the 2015 Spirit acquisition has further strengthened the group. However, there are undeniably headwinds ahead, and that makes us more cautious on the stock than we have been in the past. It's a view that seems to be shared by the wider market, with the shares currently trading on a price to earnings ratio of 8, a more than 20% discount to its historic average. The prospective yield is currently 6.2%.

Half Year Results

A combination of decreased consumer spending, intense competition, poor weather and cost headwinds, including the national living wage, business rates and duty increases, have dented performance in the first half.

The Pub Company business saw first half operating profits fall 11.4% to £136.9m, equal to 73% of group operating profits. That fall reflects a 2.2% fall in revenues, but also a 1.7 percentage point squeeze on margins as cost pressures increased. Revenue underperformance was driven by food, where value has struggled, although drinks delivered a flat like-for-like result. The Fayre & Square debrand is expected to complete by the end of the year.

The tenanted Pub Partners business delivered a better result, with revenues down 1.6% and operating profits down 0.2% to £43.7m. That result reflects a small downturn in beer volumes offset by rent improvements and cost savings.

Brewing & Brands revenue rose 7.9% with operating profits of £14.8m flat overall as margins slipped 1.1 percentage points. The lower margin reflects increased input costs and a shift in sales mix.

Net debt at the end of the period stood at £2.1bn, up slightly from the year end. The ratio of net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) is now 4.2 times. Free cash flow fell 75% to just £10.6m.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.