Annual report 2016

Financial review STRONG returns and
further dividend growth


Group revenue increased:
57.6%

Free cash flow:
£50.2m

ROCE:
9.4%

Dividend:
32.05p



Operating cash flows remained strong.

Revenue was £2,073.0m, an increase of 57.6% compared to the prior year. Excluding a £705.1m contribution from Spirit, revenue increased 4.0% to £1,367.9m. Pub Company was the biggest driver of this increase, with revenue up 68.7% and average revenue per pub rising 1.0%. The combined Pub Company business now accounts for over 81% of group revenue. Total revenue in Pub Partners was £187.9m. This included the Greene King tenanted and leased estate where revenue of £119.4m was down 2.1%, due to the impact of pub disposals. Average tenanted and leased revenue per pub increased 13.8% and average EBITDA per pub grew 14.3%, demonstrating improvements in the quality of the estate and also benefiting from the inclusion of synergies and fair value accounting. Brewing & Brands grew revenue 2.2% to £196.9m.

Operating profit before exceptionals was £392.2m, which was an increase of 53.1% on the prior year. Group operating profit margin before exceptional items was down 60bps to 18.9%, reflecting a higher contribution from the managed estate and, within this, a reduction in Pub Company margin from 19.1% to 17.7%. The reduction of the Pub Company margin was in line with expectations and reflected ongoing investment in labour and training along with the impact of the higher proportion of leasehold pubs in the Spirit estate compared to the Greene King estate.

Net interest costs before exceptional items were £135.7m and included £49.0m of interest relating to Spirit.

Profit before tax and exceptionals was £256.5m, an increase of 52.2% on last year. The tax charge before exceptional items equated to an effective tax rate of 19.3%.

Earnings per share before exceptional items of 69.9p was up 14.6%. Statutory profit before tax was £189.8m, up 60.6% on last year.

Operating cash flows remained strong. We generated free cash flow (FCF) of £50.2m, ahead of our scheduled debt repayments of £43.3m and after our core capital expenditure and dividend payments. Overall, EBITDA before exceptional items was £496.9m.

Group net debt at the year end was £2,048.4m, an increase of £679.7m from the previous year end due to acquiring net debt of £674.5m with the Spirit business.

In line with our strategic priorities, our objective is to maximise the strength and flexibility of our balance sheet, and the group has a capital structure aimed at meeting the short, medium and longer-term funding requirements of the business. The principal elements of the group’s capital structure are a shorter dated £460m revolving credit facility to June 2018 that was £315m drawn at the year end and two long-term asset-backed financing vehicles. The Greene King securitisation has secured bonds with a carrying value of £1,140.9m and an average life of 11 years, while the Spirit debenture has secured bonds with a carrying value of £788.7m and an average life of 12 years.

Our credit metrics remain strong with 96.1% of our interest costs at a fixed rate and an average cost of debt of 6.6%. As a consequence of the Spirit acquisition, fixed charge cover reduced to 2.3x from 2.9x last year, while interest cover increased to 3.3x from 3.0x last year. On a pro-forma basis, annualised net debt to EBITDA improved to 3.9x. Our Greene King secured vehicle had a free cash flow debt service cover ratio of 1.5x at the year end, giving 26% headroom. The Spirit debenture vehicle had a free cash flow debt service cover ratio of 1.9x giving headroom of 33%.

After the year end, the group issued a £300m A6 bond at a coupon of 4.06%, realising net proceeds of £180m after settling certain interest rate swap liabilities. Capitalising on our high proportion of freehold assets, this transaction increased the proportion of longer-term debt in our capital structure and took the outstanding nominal value of bonds issued by Greene King Finance plc at that point to £1,447.7m. The Greene King bond portfolio is secured against 1,543 pubs with a market value of £2.2bn and a carrying value of £1.6bn.

During the year, we invested in both maintaining and developing our existing estate. Total expenditure during the year was £168.4m, made up of £110.3m in Greene King and £58.1m in Spirit.

In addition to the acquisition of Spirit, we added 13 new pubs, investing £46.7m in our retail expansion. Total cash capital expenditure was £194.1m, including £137.5m of core capital expenditure. Core capital expenditure included £45.9m on the Spirit estate.

We disposed of 48 pubs from the combined Pub Partners estate, including six required by the CMA. We also disposed of 26 Pub Company pubs, including ten required by the CMA. Total cash proceeds were £82.6m and a net profit on disposal of £23.3m has been recognised.

The group is focused on delivering the best possible returns on our assets and on the investments we make. We are focused on capital discipline, coupling targeted investment in new build pubs, single-site acquisitions and in developing our existing estate to drive organic growth with disposals of non-core pubs. This has contributed to a 10bp improvement in group ROCE to 9.4%. These returns were achieved despite a 10bp dilutive impact from Spirit. ROCE remains comfortably ahead of the group’s cost of capital.

The board has recommended a final dividend of 23.6p per share, up 8.3%. This will be paid on 12 September 2016 to shareholders on the register at the close of business on 12 August 2016.

The proposed final dividend brings the total dividend for the year to 32.05p per share, up 7.7%. This maintains our long-term track record of annual dividend growth and is in line with the board’s policy of maintaining a minimum dividend cover of around two times underlying earnings, while continuing to invest for future growth.

The effective rate of corporation tax (before exceptional items) was 19.3% compared to 21.0% in the previous year, resulting in a charge to operating profits (before exceptional items) of £49.4m. This is slightly below the standard UK corporation tax rate due to adjustments in respect of prior periods. The exceptional tax credit of £50.5m is discussed under exceptional items.

The group’s business strategy generates revenue, profits and employment, all of which deliver substantial tax revenues for the UK government in the form of duties, VAT, income and corporation tax. In the year, total tax revenues paid and collected by the group were £570m (2015: £405m). The group’s tax policy, which has been approved by the board, aligns with this strategy and ensures that the group fulfils its obligations as a responsible UK taxpayer.

Since the year end, a formal agreement has been reached with HMRC on a number of historical tax positions. We expect to draw the remaining issue to a close and this will be heard by the Court of Appeal in July. The provision for uncertain tax positions and related interest accrued at the balance sheet date were £10.5m (2015: £31.6m) and £5.9m (2015: £13.9m) respectively.

Following the Spirit acquisition, the group now maintains three defined contribution schemes, which are open to all new employees and three defined benefit schemes, which are closed to new entrants and to future accrual.

At 1 May 2016, there was an IAS 19 pension deficit of £52.3m representing a reduction of £6.9m since the previous year end. The £52.3m comprised £48.6m in respect of Greene King schemes and £3.7m in respect of the Spirit scheme.

The deficit reduction resulting from the effect of contributions paid to the schemes and the reduction in scheme liabilities following changes to demographic assumptions are partially offset by the impact of changes to the market-derived actuarial assumptions and a reduction in the market value of the schemes’ assets since the previous year end.

Total cash contributions in the year were £12.5m for past service.

The triennial funding valuation and recovery plans have now been agreed for the three defined benefit pension schemes and future deficit recovery contributions are expected to be £3.3m per annum, a reduction of £8.6m per annum.

We recorded a net exceptional charge of £16.2m, consisting of a £25.9m charge to operating profit before tax, a £40.8m charge to finance costs and a net exceptional tax credit of £50.5m. The following items were recognised in the year:

  • A £17.5m charge for legal, professional, integration and reorganisation costs following the Spirit acquisition.
  • A net impairment charge of £32.2m (2015: £27.4m) was made against the carrying value of our pubs and other assets. This comprises an impairment charge of £79.8m offset by reversals of previously recognised impairment losses of £47.6m.
  • A net surplus on disposal of property plant and equipment, which includes a number of high alternative use value disposals, of £23.3m.
  • £39.1m of exceptional finance costs in respect of the mark-to-market movements in the fair value of interest rate swaps not qualifying for hedge accounting within the Spirit debenture.
  • The exceptional tax credit of £50.5m consists of a £11.4m tax credit on exceptional items, a deferred tax credit of £33.6m in respect of the licensed estate, a £0.7m tax credit in respect of prior periods and a £4.8m tax credit in respect of rate changes. The deferred tax credit in respect of the licensed estate includes a credit of £26.8m in relation to revaluation and rolled over gains on the licensed estate following clarification from HMRC on the treatment of certain judgmental terms.

The group completed the acquisition of Spirit Pub Company plc on 23 June 2015 for consideration of £763.1m.

A fair value exercise was undertaken upon completion and the final assessment in respect of the assets and liabilities acquired has been concluded. The goodwill on acquisition following the fair value exercise is £434.0m.

Key fair values include the following:

  • Property, plant and equipment values, for which valuations have been performed by external surveyors, of £1,413.4m.
  • A £168.3m intangible operating lease asset.
  • The brands acquired with the Spirit business have been valued at £16.1m.
  • A £312.7m liability recognised in respect of lease arrangements that are not considered to have market rate terms.
  • Derivative liabilities in respect of interest rate swaps of £165.2m.
  • Deferred tax asset of £68.7m recognised relating to losses, derivatives and other temporary differences.
  • Net debt acquired, which totalled £674.5m and included cash of £147.5m.

The impact of fair value adjustments and other accounting alignments on the annual results has been to increase operating profit by £7.1m, largely as a result of the treatment of the off-market lease liability. The benefit to profit before tax and exceptionals has been £7.4m. There has been no impact on cash.

The 2016/17 pre-exceptional tax rate is expected to be c.20%.

In Pub Company, we anticipate opening 10–15 pubs in the current year and disposing of 65–75 pubs from the estate.

In Pub Partners, we expect to reduce the estate by 50–65 pubs in the financial year. These disposals, as well as potential transfers to Pub Company, will improve the quality of the estate while generating cash for other uses across the business.

We anticipate spending £130–140m in the current financial year, excluding brand optimisation capex, on maintaining and developing our pubs, in order to ensure that they remain attractive places for customers to spend their time.

Spend on the brand optimisation programme is expected to total £40m–50m in the current financial year – out of a total spend over three years of £120–150m – and we are targeting EBITDA returns significantly ahead of our cost of capital.

Our blended cost of debt is expected to be c.6.3%.

Income statement analysis

Greene King
Spirit1
F16
£m
Synergies
£m
Total
£m
F16
£m
Synergies
£m
Accounting
adjustments2
£m
Total
£m
Total
group
£m
Revenue 1,367.9 1,367.9 705.1 705.1 2,073.0
EBITDA3 326.5 5.6 332.1 143.4 11.1 10.3 164.8 496.9
Operating profit3 258.3 5.6 263.9 110.1 11.1 7.1 128.3 392.2
Net finance cost3 (86.7) (86.7) (49.3) 0.3 (49.0) (135.7)
Profit before tax3 171.6 5.6 177.2 60.8 11.1 7.4 79.3 256.5

Operating profit analysis3

Greene King
Spirit1
F16
£m
Synergies
£m
Total
£m
F16
£m
Synergies
£m
Accounting
adjustments2
£m
Total
£m
Total
group
£m
Pub Company197.23.5200.782.910.05.698.5299.2
Pub Partners54.41.155.527.21.11.529.885.3
Brewing & Brands31.71.032.732.7
Corporate(25.0)(25.0)(25.0)
Total258.35.6263.9110.111.17.1128.3392.2

Kirk Davis
Chief financial officer

28 June 2016

  1. Post acquisition since 23 June 2015.
  2. Accounting alignments and income statement impact of fair value adjustments.
  3. Before exceptional items.