Could Greene King make investors blue?

Greene King is one of the UK’s leading pub retailers and brewers. It operates over 2,400 pubs and restaurants and runs two breweries. The company was established in 1799 and has been very successful in recent times.

Companies like this usually need some finance in order to be successful. There are two ways that are most common to companies to raise finance.  Money can be raised through equity or capital of the company. Money can also be raised through debt finance. Equity finance has been a popular option for companies for many years, whereas debt finance has only really come to fruition within the last 30 years.

Greene King has raised finance through their equity. The company has significantly high net debt and has done for many years. In 2008 the net debt was as high as £1,605m (Greene King, 2011). The majority of this net debt is made up of securitised debt. These are loans given to companies which are secured with their assets. Although these figures seem alarming, Greene King has taken this approach for years. The company no longer has any short term debt outstanding and some borrowings are not fully due until 2036 (Greene King, 2011).

Some people believe that companies should not be run in this manner but this approach is not uncommon within this particular industry. Greene King has high equity because of all the properties that have been acquired over the years. The company’s gearing ratio has been above 100% for a long time. This states that the company is highly geared; relying on borrowing for the majority of its capital.

Weighted average cost of capital (WACC) – is calculated by “weighting the cost of debt and equity in proportion to their contributions to the total capital of the firm” (Arnold, 2008). Companies use this figure to see how much interest is being paid on the money that it is financing. Realistic cash flows can be developed from this calculation; allowing the company to interpret whether acquisitions or mergers can be made. Greene King invests heavily in new acquisitions so it is important that these calculations are correct. The company would not want to place itself in a vulnerable position.

 Rooney Anand – Greene King Chief Executive

Greene King recently suggested that its half-yearly profits were higher than past years but the Chief Executive of the company, Rooney Anand, was quick to suggest that 2012 would be a tough year of trading for Greene King (BBC News, 2011). If this is the case, should Greene King continue to receive the majority of their borrowings in the way they do currently?

I believe that the answer is simply yes. Before the financial crisis it was simple for people in well established countries to borrow money to expand their businesses. Before the crisis, in the US, more than half of the country’s borrowings to companies were financed through asset-backed securities (Financial Times, 2011). Although the UK and the US are struggling more than in the past, it is still possible to have a business that is consistently successful and profitable. However, some companies can not necessarily be as successful without the funding. A company in this situation may not be able to progress or may even begin to struggle. Greene King does raise internal finance and therefore does not rely solely on external finance. It is very likely that the company would not be as successful as it is currently is without the borrowings that it receives.

Greene King maximise their shareholder value by “maintaining a strong credit rating and a core level of debt which optimises the weighted average cost of capital (WACC) and shareholder value” (Greene King, 2011).  This statement shows that the company are aware of the potential implications from their current net debt. It also shows that they take WACC into account in order to be as successful as they are. The debt is actually maintained to a level that benefits the WACC.

Greene King has operated in this manner for a long time. The company has been successful under this business plan and has not shown any ill effects from recent obstacles such as the smoking ban and declining property prices. The company is seen as being volatile due to the level of net debt and high gearing. However, the securitised debt is currently under control and is not affecting the progression of the company. Greene King is also classed as being a stable company through their annual credit score and rating (FAME, 2012).

Businesses such as Peacocks have been recently unsuccessful but this does not mean that all companies will follow in their footsteps. It is unfair for all companies to be tarred with the same brush but it is inevitable that the general public become concerned when well known companies begin to fail. Greene King has not had too much public attention in comparison as their business model has been successful.  I believe that if larger companies were given time and co-operation from their lenders then it may be possible for them to replicate these successful results.

 

Sources used – G Arnold, BBC News, FAME, Financial Times