Greene King: a pub chain going cheap
You should take advantage of the good cheer on offer at Greene King, says Matthew Partridge.
You should take advantage of the good cheer on offer at Greene King.
Here at MoneyWeek we generally tend to tip companies towards the value end of the spectrum. That's partly because we just like a bargain, and partly because we believe that, right now, stocks in general are overpriced. One British company that is currently an exception to that rule is Greene King, which operates more than 3,100 pubs, hotels and restaurants, as well as also brewing large amounts of beer at its breweries in Bury St Edmunds and Dunbar. At the moment, Greene King is trading on just seven times forward earnings, and at a discount of 28% to its book value. It also offers a very attractive dividend yield of more than 6%.
So what's going on? There are several reasons for this relatively low valuation. Firstly, there are fears that higher food (and wage) inflation will push up costs, even while economic uncertainty is squeezing demand over the past year, consumer spending on eating out has either fallen, or at best stagnated, depending on which measure you use.
There's also the issue of whether Greene King's business model, based on buying up smaller companies and cutting costs by exploiting economies of scale, will deliver the expected benefits or simply end up alienating consumers who resent the change of ownership at their local pubs. Green King's sales growth has lagged its rivals on a like-for-like basis, for example.
These are all valid concerns, but we also think that, at current levels, they are priced in. Greene King's operating margins have held relatively constant at 15%-20%, while return on equity is a solid 8%. There is certainly room for improvement, but the company looks a lot more solid than several other firms trading at similarly deep discounts. Free cash flow is also roughly twice the dividend, which should help it keep paying out, even while reducing debt.
Meanwhile, in an effort to boost sales growth and ensure it retains a wide range of customers, the company has been investing heavily in upgrading its customer service, hiring more staff and overhauling its range of food and beers. Even if sales growth continues to disappoint, the ambitious cost-cutting programme should help boost profits and give Greene King a cushion in the event of a serious downturn.
I'd suggest you buy Greene King at 459p. While IG Index has a minimum price of £1 per point, I'd suggest you go for £4 a point instead, and set the stop-loss at 345p (in effect a loss of 25% from the current levels). This gives you a potential downside of £456.
Trading techniques: the cover-story curse
Some contrarian investors talk about the idea of the magazine cover "curse" the observation that companies which become high-profile enough to make the cover of magazines often end up lagging the market later. The rationale behind this idea is that the media will only run a story when sentiment reaches an extreme, making positive coverage a negative indicator.
One infamous example of a magazine getting it wrong was BusinessWeek (now Bloomberg BusinessWeek) in 1979, with its cover story on the "Death of Equities", which came just before the epic bull market of the 1980s took off. Similarly, in late 1999, Time magazine made Amazon's Jeff Bezos its Person of the Year only for his company's stock to dive by 86% over the next 12 months amid the wider tech-stock crash.
Several studies suggest that there is something to the curse. Citigroup's Gregory Marks and Brent Donnelly studied 44 Economist covers between 1998 and 2016, and found that going against the image (though not necessarily the tone of the actual article) would prove profitable two-thirds of the time. Buy assets which had earned a bearish cover, and you'd make 18% over the next year; short assets on bullish covers, and you'd make 7.5%.
That said, it doesn't always work. A 2007 study by professors at the University of Richmond looked at companies featured on the covers of Fortune, Business Week and Forbes between 1983 and 2002. They found that once you compared them with the overall market, there was no significant difference in subsequent performance between those featured positively and those portrayed negatively.
How my tipsare doing
Despite recent market declines, our long positions are doing well: spread-better IG Group, car-maker Renault and oil firm Petrobras sit on paper profits of £503, £662.50 and £712.50 respectively. Despite falling back a bit, our positions in commercial property group Hammerson and computer-chip specialist Micron are still in the black, on small profits of £36 and £28.20. Overall, our longs are on a total profit of £1,942, slightly up on the previous profit of £1,784.
Unsurprisingly given the recent market turmoil, our short positions have also done well. Cryptocurrency bitcoin has continued to slide, falling to $6,783. It is now back to where it was in November, before the price doubled in less than a fortnight. This means our total profit from shorting the cryptocurrency is now £1,110.50. Ongoing worries about a trade war means the S&P 500 is at 2,642, slightly higher than it was a fortnight ago. However, the trade it is still making a profit of £185. This means that our total profits are £2,224 when you take into account the losses from closed positions.
I'm going to stick with Hammerson for the moment, on the back of the recent price rise. However, since we've held it for more than six months, it's definitely one we're considering dumping, and in any case it's pretty close to our stop-loss of 510p. While we've held IG Group, Renault and Petrobras for roughly a year, I'm going to stick with them for now although I'll adjust the stop-losses on IG and Renault upwards to 700p and €90 respectively.
While bitcoin has collapsed since the start of the year, I'm confident it will fall further. Still, I will move the stop-loss down to $10,000 to be on the safe side and lock in some profits. Similarly, I'm going to reduce the stop-loss on the S&P 500 trade to 2,775.