Numis downgrades Greene King on valuation, margin pressure

Greene King shares have outperformed the wider UK stock market over the last three months but amid continued pressure on margins, Numis downgraded its recommendation to 'hold' from 'add'.

As Greene King reaches its year end, the broker update its assumptions, with recent industry data from the Peach Tracker
suggesting market trends since the company last reported in January are largely unchanged with like-for-like sales averaging growth of 1% up to March versus 0.6% for the prior nine months but a disappointing Easter period at -3.8%.

For GNK, Numis assumed 0.8% growth for the full year and sees a likely improvement to 1.0% for the 2018 financial year.

However, 2018 will be a second year of cost pressures, with a recent update from JD Wetherspoon underlining that costs will remain an issue for pubcos, with JDW estimating it will need to grow LFL sales by 3-4% to maintain operating profit in 2018.

Although GNK has good record of cost control, it faces headwinds including the minimum wage of around £20m, apprentice levy of around£3.5m, rates and utilities of £11m and an unquantified level of cost of goods sold, so with the synergies from the Spirit acquisition having largely run their course the group will have to look to wider efficiencies to mitigate headwinds.

Moreover, with LFLs having over the last year been held back by weak performance from the value dining segment, particularly the 'Fayre & Square' outlets from Spirit, Numis estimated a 50 basis point drag on group sales "and a more material profit impact".

This is being addressed through site disposals and conversion to more successful formats, costing £30-40m, but it means that by the 2019 financial year the issue should be resolved to boost confidence in a LFL sales improvement in from then on.

Analyst Tim Barrett sees the stock as underpinned by a well-covered dividend but adjusted his sum-of-the-parts valuation for the new forecasts gives upside of only 8%, explaining the downgrade.