Greene King

I'm considering buying some shares in Greene King. This post is my attempt to convince myself that it's a good buy.

Financials - 2006/2007 - pre-exceptionals
Revenue £917.5m
Operating profit £218.1m
Profit before tax £139.8m
Net profit £97.8m

Net tangible assets £208.3m, but this is not based on current land values. By October this was down to £97.5m due to buybacks and acquisitions.

Breaking things down by segment:

Pub company
Revenue £546.0m
Costs £435.3m
Profit £110.7m

Pub partners
Revenue £164.0m
Costs £89.3m
Profit £74.7m

Brewing
Revenue £91.1m (£126.8m inc. internal revenue)
Costs £68.1m
Profit £23.0m

Belhaven
Revenue £116.4m (£118.0m)
Costs £93.1m
Profit £23.3m

Central
Finance costs £88.4m
Tax £37.3m

Short term forecast

Could be problematic. A serious downturn in the UK is going to hit beer sales somewhat, but will more seriously affect dining, which Greene King is increasingly exposed to. It's heavily indebted, so the question is: can it survive a sharp recession?

Let's assume a 20% fall in brewing sales, and assume that 2/3 of the brewing costs are fixed. I'm not sure what proportion of Belhaven's profits are brewing-related - suspect not a lot, so lets focus on the main brewing segment. A 20% fall in revenue and a 6.7% fall in costs means a profit of £9.3m.

Let's assume a 40% drop off in pub revenue, on the basis that much of this is food-related. Again, let's assume 2/3 of costs are fixed. That's a £50.2m loss on the pub company.

Applying that to Belhaven: that makes an £11m loss.

Pub partners, let's assume a 20% fall in rent, and a 10% fall in costs. That's a profit of £50.8m.

So overall, in what I think is a pretty disastrous scenario, the company could make an operating loss of £1.1m. Finance costs are about £82m, so that makes a total loss of £83.1m. They have £98.5m cash on hand, so a one-year performance like that wouldn't cripple them. Obviously we'll assume they cut the dividend to zero, and cease capex.

Let's assume things start to pick up gradually:

Beer sales recover to 15% down on current levels. Brewing profit = £12.7m.

Pub revenue recovers to 25% down. Pub company loses £1.9m. Belhaven makes £1.9m.

Pub partners rent remains 20% down, since tenant landlords will still be suffering. They make £50.8m.

So that makes £63.5m operating profit. Still about £20m short of their finance costs. However, if the slow times are continuing for a number of years, fixed costs can probably be reduced by making staff redundant. Chances are that can make up the shortfall, and so during a slow recovery they can just about break even.

So a sharp recession could be very painful, but Greene King should survive. We can therefore value the company on its long-term prospects.

Long term forecast
Long term Greene King can grow through increasing its market share and acquisitions. EPS can increase through buybacks. I think the pub business is probably static over the long run.

As we've seen, Greene King should be able to cope during a recession, and should perform fairly strongly during the good times. At a P/E ratio of 11, it can have a dividend yield of 3% and still reinvest two thirds of its profits in growing the business.

Fair valuation
I see no reason not to take current profits as the norm, so applying a P/E ratio of 11 to £97.8m profit, I put a value on Greene King of £1075.8m, or in other words a share price of exactly 800p (not fixed - honest).

Current share price is 521.5p, so a discount of 35% on what I consider fair value.

Conclusion
I should put my money where my mouth is and buy. I suspect we will see further falls in the share price, but this would be an opportunity to buy more.