Stockwatch: Shares for income and capital protection

After I drew attention to Young's normalised pre-tax profit up 15.7% on revenue up 7.8%, that achievement is emphasised by relatively modest – albeit still good - interims from Greene King.

Its results profile is mixed as a result of selling 275 pubs which has tipped some measures slightly negative. However, adjusting for this disposal the retained business grew pre-tax profit by 3% to £79.2 million on revenue up 3.3% to £614.9 million. Adjusted basic earnings per share (EPS) rose 5.3% to 29.6p and strong cash flow helped the dividend up 4.6% to 7.95p. Historic return on capital employed as estimated like-for-like by Company REFS is 12.2% versus 6.3% for Young's. These latest results cite a "20 basis point improvement to 9.2%" although approaches to calculation can vary.

Pub shares merit considering for 2015 onwards

There are several reasons to keep results from well-managed/branded pubs, in focus.

Firstly, both the Prime Minister's citing "red warning lights in the global economy" and the Office for Budget Responsibility (OBR) warning that 60% of government spending cuts are yet to come suggest it would be wise to batten down.

Cyclical and growth shares on high ratings are becoming exposed, and it is wiser to put more emphasis on capital protection with a reasonable dividend – by which I mean a 3-4% yield as realistic, than 5%+.

Secondly, well-managed pubs offering a good value experience should be relatively resilient to any downturn in the British economy; people being less willing to compromise on this social mainstay. Cheaper alcohol from supermarkets means competition – but well-managed operators can also benefit from customers being more aware as to price. Greene King's message is: "With real incomes struggling to grow, customers remain cautious about spending on eating and drinking out... we will continue to tailor our customer-focused strategy..."

Despite a survey suggesting lower spending on eating and drinking out this Christmas, Greene King reports bookings for the festive period up 7.2% on last year.

Thirdly, trading updates are significant to assessing the wider economy. Greene King cites some slowdown in the North, since its Southern estate is strongly out-performing (one reason I have emphasised Young's as a defensive share, based in London and the South). It implies a two-tier UK economy with some recovery underway in private business mainly in the South, while a greater proportion of public sector employees in the North face more challenges. The medium-term outlook for UK public spending implies this disparity is set to worsen.

Shares down 18% from a 2014 all-time high

Greene King's chart profile shows strong gains from mid-2012 to 925p in early 2014, then a consistent retreat – typical of many shares amid/after quantitative easing-driven exuberance. The price recently reached 740p and is unchanged at 760p after the latest results. Part of this de-rating has been to establish a price to refresh Greene King's appeal: while the financial summary shows a respectable earnings record it lacks dynamism for growth investors. Those value-conscious may balk at the lack of asset backing compared with a circa 17% discount to net tangible assets at Young's. This leaves the dividend which is now a useful 4% covered about twice by earnings and well-supported by cash flow.

Risk/reward profile is more attractive

As investors re-consider the security of dividends on cyclical shares, it improves the competitiveness of a 4% yield hence introduces quite a support level for Greene King. This company is less likely to issue an extent of warning to hit the price. The profile can therefore interest an income-oriented investor seeking capital protection also: Greene King helps you achieve quality income whereas Young's offers only about a 1.6% yield. These shares have complementary merits in a conservative equities portfolio.

Investment in the core estate is expected to be about £85 million this year, in context of the 19 October balance sheet showing £2.2 billion property/plant/equipment. Some 54% of 1,914 pubs, restaurants and hotels in the group are directly operated and 46% either tenanted, leased or franchised. Brands include Hungry Horse, Old English Inns, Eating Inn and Loch Fyne Seafood & Grill, with £702 million accounted goodwill versus a negligible £20 million at Young's. Brewing accounted for 15% of the last financial year's revenue and 11% of profit, and has increased its share of the UK market over 10%.

Relatively high debt, albeit hedged against interest rate rises

The group is substantially geared with £1,375 million longer-term debt and £189 million short-term, in context of £1,024 million net assets – and mind how 69% of this amount is goodwill. Cash flow and disposal proceeds have reduced net debt by £73 million to £1,362 million although finance costs still swallowed about a third of interim operating profit. Greene King's gearing of 133% compares with about 30% for Young's although interest rate hedges are in place for 97% of variable rate debt and the blended average cost of debt is 6.0%. The debt profile is therefore not what investors want to see, albeit is manageable. It looks another factor eroding the share price this year in anticipation that higher interest rates will make the company riskier; but the price fall has created a better yield to compensate.

Verdict: a useful pub-co to consider

Greene King doesn't quite appeal like Young's, for a cautious investor, but can help portfolio balance in a scenario where cyclical and growth shares alike may be exposed. If you believe the OBR, that Britain's recovery will run out of steam as the next government squeezes public spending and there is no real boost from exports, then a more defensive stance is justified – e.g. via well-managed pub-co shares. As a mid-cap, Greene King also offers better liquidity than AIM-listed Young's.

For more information see greeneking.co.uk

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.