Chief executive's review A transformational year
It has been a transformational year for Greene King, with the acquisition of Spirit in June 2015 followed by significant progress integrating the ‘best of both’ businesses and realising cost synergies, helping to deliver further improvement in earnings and dividends, and strong returns.
In the first half, improvements in the economic environment, including increased consumer confidence and sustained real income growth, were slow to positively impact the UK eating and drinking out market. As the UK referendum approached in the second half, the environment softened and consumers appeared more reluctant to spend discretionary income due to the uncertainty.
Following the UK’s vote to leave the European Union, the increasingly uncertain trading environment is likely to weigh on consumer sentiment in the near term. However, Greene King has a strong track record of performing well in challenging trading environments and we have levers to pull within our business, particularly following the Spirit acquisition, to refocus our investment and help limit the indirect impact from lower consumer confidence. In addition, we have limited exposure to European sales, although we have some exposure to foreign exchange rate movements through overseas sourcing. We will look to mitigate the impact of this as far as possible.
Outside of the consequences of the vote, UK eating and drinking out remains a dynamic market with intense competition for every pound in the consumer pocket. This environment of increasing consumer choice extends beyond the traditional pub and restaurant sector and includes the supermarkets and the takeaway aggregators who have made eating at home more attractive. Understanding this, and ensuring our offer is compelling enough to compete successfully with this broader competitive set, is increasingly important for delivering long-term growth.
Consumers remain highly value conscious with a heightened awareness of price, a demand for excellent and personalised service, and a desire for higher quality on the plate and in the glass. These trends will be exacerbated by the uncertainty surrounding Brexit and we are well positioned to take advantage of any weakening in spending power utilising our successful value brands and formats.
They are also seeking experiences they can share with both friends and family and with a much wider audience on social media. Our aim is to create experiences that our customers will value and remember, and that they want to share with others. While digital and technology will increasingly contribute to the overall customer experience, it is the physical interaction with our people and our pubs that will enhance these experiences. We believe that our high quality estate, together with our approach to digital, can set us apart from our broad competitive set.
Our people are core to our business and we constantly strive to pay them appropriately for their hard work while also ensuring we maintain a high level of investment in their development and training. We remain confident of being able to mitigate most of the impact from the ongoing increases in the National Living Wage. We continue to expect the benefits of mitigating actions to be fully achieved in 2018/19 and there are no changes to our estimate that the incremental impact, over and above general wage inflation, will be £2m in the current financial year and will reach an annualised run rate of £6m per annum in 2018/19.
Now that the revised statutory Pubs Code has been announced, and assuming there are no further changes, we are planning for the introduction of the Code at the end of July 2016. We believe the overall financial impact on the group will be immaterial.
Total revenue grew 57.6% to £2,073.0m while operating profit1 was 53.1% higher than last year at £392.2m, including £16.7m of synergies achieved during the year.
The operating margin was 18.9%, 0.6%pts lower than last year. This comprised a positive contribution from cost synergies, diluted by a higher contribution from managed pubs, higher lease costs following the Spirit acquisition and incremental investment in our people and in customer service.
In Pub Company, this investment in our people helped to drive LFL sales growth of 1.5%, ahead of the market2, and included LFL sales growth in the original Greene King managed estate of 1.9%. Total sales growth in Pub Company was 68.7% while operating profit grew by 56.8% to £299.2m. 13 new pubs were opened during the year.
Having achieved a record customer satisfaction score in Greene King Pub Company in the first half, further progress was achieved in the second half resulting in a 7.9%pts increase in the full year. We also saw an improved trend in team member retention and in our food safety ratings. The improvements in these metrics indicate the success of our teams in continuing with business as usual during the integration process.
The tenanted and leased businesses were successfully integrated at the end of the first half and the combined Pub Partners business grew LFL net income by 2.7% in the year. Average EBITDA per pub increased by 14.3% reflecting further improvements in estate quality as a result of the Spirit acquisition, the disposal of 48 pubs from the combined estate and synergy contribution.
Brewing & Brands achieved record revenue of £196.9m, including 2.9% OBV growth, and we extended our share of the UK ale market by 40bps to 10.5%. Operating profit grew 9.7% to £32.7m.
The integration of Spirit progressed ahead of plan, with synergy realisation of £16.7m in the year exceeding our expectations. Overall, the positive group performance delivered a 24.1% increase in net cash flow generated from operations and we again covered our debt service obligation, core capital expenditure and dividend from internally generated cash. Net debt to EBITDA improved to 3.9x.
Adjusted earnings per share grew 14.6% to 69.9p and, as a result of this growth and our confidence in the future, we have declared a 7.7% increase in the dividend per share, maintaining our long-term progressive dividend policy.
The business achieved another year of robust returns, generating a ten basis point increase in ROCE to 9.4%, which remains comfortably ahead of our weighted average cost of capital (WACC).
- Throughout this review, operating profit, operating profit margin and EBITDA are stated on a pre-exceptional basis.
- Coffer Peach Business Tracker.
On 23 June 2015, we completed the acquisition of Spirit Pub Company, adding 791 managed pubs and 416 tenanted and leased pubs to the estate. Following a thorough review of Spirit, we commenced the exciting task of integrating these two leading pub businesses using a ‘best of both’ companies approach. At the end of the first half of the year, our two tenanted and leased businesses were integrated ahead of schedule. We also drove strong acceptance of the Greene King beer brands within Spirit’s managed pubs and we announced a decision to retain both the Spirit and Greene King head offices. During the second half, the Greene King beer portfolio gained further traction within Spirit pubs, we commenced the roll out of the ‘best of both’ pub IT system and the majority of the people transition was completed.
The scale of change in the combined business since the acquisition is significant. While maintaining trading momentum, we have driven fundamental improvements to how the business is structured and run. Keeping Spirit’s Burton office as the headquarters for our managed pub business and putting together a senior management team with the requisite retailing experience and skills has given us a platform to create an exceptional retailing business that can generate sustainable competitive advantage.
Following a strong start, momentum with the realisation of cost synergies continued in the second half with good progress on procurement, where we saw a number of supplier negotiations concluded sooner than anticipated. As a result, £16.7m of cost synergies were achieved in the year compared with our original expectation of around £12m. We continue to anticipate annual cost synergies in the region of £35m by the end of 2017/18, of which 80% will be realised by the end of this financial year. Non-recurring costs of achieving these synergies are still expected to total £25m. Our intention remains to invest cost synergies in excess of our stated target to strengthen key areas within Pub Company such as our people, our systems and our brands.
The acquisition of Spirit in June 2015 was followed by significant progress integrating the best of both businesses.
We acquired a strong portfolio of brands and formats with Spirit – one that would have been very difficult to replicate organically – and we continue to anticipate material benefits from optimising the combined brand portfolio, which will provide an exciting growth opportunity over the next few years.
The combined business has 20 brands and formats and our plan is to reduce this to around ten. We are evolving the future brand portfolio and plan to focus on five growth retail brands and formats: Hungry Horse, Flaming Grill, Farmhouse Inns, Chef & Brewer and Greene King. We will also continue to develop our hotels and Metropolitan, our premium London pub format.
In order to select the growth brands and formats to invest in, we looked at the consumer relevance and financial performance of each brand, the long-term opportunities to grow and expand and the proximity to other pubs within the combined group.
There is potential profit upside from investment in over 300 of our existing pubs to reposition them into the growth brands over the next three years. Our priority in 2016/17 is to convert around 100 Fayre & Square pubs into the growth brands, of which the majority will be rebranded as Hungry Horse.
We also plan to simplify our Local Pubs estate. We will reduce the number of formats and we will replace any existing retail branding with Greene King branding, considerably increasing the size of the Greene King branded estate and creating a significant pub retail brand in the UK eating and drinking out market.
In the current year, we expect to spend around £40–50m on these conversions and anticipate generating EBITDA returns significantly above our cost of capital. We expect a £1m dilutive profit impact in the first year, including the impact of additional opening costs.
Best for our communities
Our pubs are at the heart of the community and have a unique opportunity to play an active role in the communities they serve. We understand the importance of operating a sustainable and responsible business and, as an industry leader, it is our duty to set an example by delivering a winning social responsibility programme.
During the year, we were proud to deliver the following initiatives:
- in March we announced that our teams and customers raised £2m for our charity partner, Macmillan Cancer Support, doubling our initial target. To mark the milestone, we were pleased to renew our partnership with Macmillan Cancer Support for a further three years;
- a partnership with The Prince’s Trust to launch ten programmes across the country giving unemployed young people an opportunity to step into work;
- for the third year running, we donated to the Pub is the Hub Community Services Fund in order to help to support rural pubs that want to diversify their services for the benefit of their communities; and
- further reduction in water consumption with Spirit named as the Water Efficient Project of the Year at the 2015 Energy Awards.
Trading in the first eight weeks of the year has strengthened, helped by the European Football Championships and better weather in May, with Pub Company LFL sales up 2.8%. We are pleased with the initial performance of the brand optimisation programme and the exciting opportunity this presents to deliver long-term growth, and today we have outlined five strategic priorities to deliver our vision of being the best pub company in Britain.
The increasing uncertainty surrounding the UK’s future withdrawal from the European Union is likely to have a negative impact on the economy and on consumer confidence in the near term. However, with our track record of success in previous challenging conditions, our strong balance sheet and the limited direct impact on our business from Brexit, we remain confident that our strategy will drive further growth in earnings, returns and dividends and we look forward to delivering further financial and strategic progress in the current financial year.
28 June 2016
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