One of the investing lessons I’ve learned over the years is that cyclical businesses usually take longer to hit rock bottom than you’d expect.
Pub groups are a good example of this. Shares of Greene King (LSE: GNK) have now fallen by 25% so far this year. They’re worth around 45% less than when they peaked at the end of 2015.
Is this stock finally cheap enough to buy? Perhaps. But today’s figures suggest to me that trading is likely to remain tough as we head into 2018.
Mixed figures
Adjusted pre-tax earnings fell by 8% to £127.9m during the 24 weeks to 15 October, while revenue fell by 1.2% to £1,031.4m. This may not seem like a big drop in sales, but it’s important to remember that to keep pace with inflation, sales should be rising by a few percent at least.
Group costs are expected to rise by £60m this year, but management expects “to deliver £40m-£45m of cost savings,” to offset some of these increases.
One concern for me is that Greene King is still in the process of integrating and optimising its pub brands, following the 2015 acquisition of Spirit Pubs. This process inevitably carries upfront costs and some risk, even if the end result is successful.
A turnaround opportunity
The Suffolk-based group’s net debt is now 4.2x times earnings before interest, tax, depreciation and amortisation (EBITDA), up from 4 times at the end of last year. Management expects this ratio to be “relatively stable”, but I’m concerned it could rise further.
The interim dividend has been left unchanged at 8.8p. Assuming the final dividend is also flat, the stock now offers a yield of 6.3%. Greene King says that this is “attractive and sustainable”, but I’d caution that if trading remains difficult next year, this payout could come under pressure.
The opinion coming out of the City after today’s results seems to be that analysts’ earnings forecasts are now likely to fall. So the stock’s forecast P/E of 8 may not be quite as cheap as it seems.
I expect Greene King to deliver a medium-term recovery. But I don’t think there’s any rush to buy just yet.
A Woodford pick I’d buy
If you’re happy to invest in sin stocks, then I believe tobacco giant Imperial Brands (LSE: IMB) could prove a more profitable alternative to Greene King.
The group’s share price dipped earlier this week after wholesaler Palmer & Harvey went into administration. P&H was one of the main distributors of tobacco products in the UK, and Imperial was forced to admit that this situation is likely to result in a one-off loss of £160m of operating profit.
However, the group has contingency plans in place for distribution and this loss looks small when measured against last year’s adjusted operating profit of £3,761m. The group’s overall valuation also looks modest when compared to key rivals.
Imperial stock currently trades on a forecast P/E of 11, with a prospective yield of 6.1%. In contrast, British American Tobacco trades on 17 times forecast earnings with a yield of 3.8%.
In my view, there’s no obvious reason for Imperial to trade at such a big discount. That’s a view shared by fund manager Neil Woodford, who bought more shares in October at what he described as an “appealing and unjustified share price”.
