Loch Fine

Greene King's 2007/08 results were a ray of sunshine in an otherwise overcast pub sector sky.

Annual turnover up five per cent, operating profits up eight per cent and pre-tax profits up two per cent. Lob in adjusted earnings per share growth of 14 per cent and a full dividend of 26p, also up 14 per cent, and Greene King executives had cause for quiet celebration, the fifth decade of uninterrupted earnings growth.

Drilling down into the numbers, the brewer's managed pub division, which includes the Hungry Horse brand plus the Loch Fyne seafood restaurant business acquired last year, saw growth across revenues, EBITDA and operating profits all in the mid to high single digits.

Impressive also was the profitability of Greene King's tenanted and leased pub arm. While revenues rose two per cent to £167.2m, EBITDA grew nine per cent, as did operating profit, to £116.5m.

But the star performer was Belhaven, Greene King's Scottish business.

With sales up eight per cent and operating profits up a whopping 18 per cent, Greene King chief executive Rooney Anand paid tribute to Belhaven's retiring managing director Stuart Ross, noting that the trading performance of the business since the introduction of the Scottish smoking ban in 2006 was a "valediction" of Ross' commitment and effort.

The one fly in the ointment was the group's brewing division. While own-brewed volumes were up six per cent on the previous year, with sales of third party lager and other drinks sales declining and costs up, overall revenue fell three per cent and operating profits were down six per cent.

Still, the City responded to the figures in positive fashion, sending Greene King's shares up by more than eight per cent. Bar the odd minor tweak to forecasts, analysts certainly seemed happy enough with the group's trading profile.

Good numbers

"Good numbers in a difficult environment," said Blue Oar Securities, while James Ainley of JP Morgan recognised the lower-than-expected central cost base and better-than-expected performances across the group's Scottish Belhaven estate and its tenanted and leased business elsewhere in the UK. UBS Securities' Simon French noted profit numbers three per cent ahead of his firm's estimates; the group was "a compelling investment story", he said.

However, even the City's positive reaction did little to blunt Anand's determination to argue Greene King's case for being the best in the business. Answering questions from journalists about the group's operations, Anand was as combative as ever. Asked about Loch Fyne's performance since it became part of Greene King for £64.2m last year - and whether he thought the acquisition merited the level of 'puzzlement' in some quarters of the pub trade - Anand's irritation with the industry grapevine was apparent.

"I find what other people choose to say about our deals intriguing," he said, a nod towards observers - interested or otherwise - who'd questioned the viability of a product as sensitive as seafood being handled by a pub operator.

But Loch Fyne had performed in line with the expectations prevailing at the time it was bought, Anand said. Like-for-like sales were ahead, operating margins up 2.7 percentage points and with a conversion roll-out of the brand planned across parts of the Greene King estate, the brewer would be looking to take the current 39 sites to 50 by the financial year end.

Anand was quick to admit that Greene King has learnt from Loch Fyne and other businesses it had bought. "We've learnt a lot from Hardys & Hansons too about back-of-house and kitchen requirements in food-led operations and we've backed that up with investment," he said.

While sanguine about the talk surrounding his company's ability to handle a business like Loch Fyne - and it seems that Greene King can - it was apparent that industry speculation surrounding its move for Belhaven had raised his hackles. But, he said, "at the end of the day you've got to take what your peers say about your business with a pinch of salt."

Nevertheless, Anand is having the last laugh on the subject of Belhaven.

"Yes, the ban was disruptive," he said. "But I've been encouraged by our results in Scotland. The performance bears out what we thought, that in year one of a ban there would be issues, while year two would see a semi-recovery, and trading become more stabilised."

Yet Anand said he was not suggesting Greene King's English pubs would see the sort of hike in operating profits witnessed by Belhaven, which saw investment in the area of food and continued growth in its beer brands.

Not immune

In truth, few would expect the picture to be repeated south of the border. Even a company as well run as Greene King cannot - and does not expect to be - immune to the challenges facing the licensed sector.

It will seek to mitigate the effects of the current tough market in a number of ways. Maintaining standards across its pub estate and retail initiatives offering both value for money and quality will be paramount.

Elsewhere, Greene King is going to have to keep a close eye on costs, both at its own production centre in Bury St Edmunds and across its pubs estate. Anand pointed to the group offsetting the inflation on key cost items of £8.1m with £9.3m of costs savings. The pressure will be on to maintain this sort of balancing act.

Increased costs were at the forefront of the minds of the 500 Greene King tenants who responded to a poll in which they were asked to rank what they believed where the main challenges in the last year.

Nearly 90 per cent cited rising costs as the main challenge, followed by lower consumer spending (78 per cent) and supermarket pricing (76 per cent). The smoking ban polled 63 per cent.

Anand acknowledged that costs were rising across the board, but said businesses had to "control the controllable".

"We need to attack variable costs," he said. On the brewing side, Anand stressed the group would "take a knife to the costbase in order to protect marketing budgets", pointing to the strength of its three core brands: IPA, Abbot Ale and Old Speckled Hen.

Initiatives being offered meanwhile to tenants included Share & Save, a third party purchasing arrangement.

"This can add 10 per cent to the bottom line of a pub that participates in it. Plus we offer support on things such as electricity and gas bills and credit card fulfilment charges," Anand said, adding that however difficult the environment some licensees just wouldn't bring themselves to accept help from their brewer.

On the question of rents, Anand said Greene King "optimised rents, not maximised them". It was a case of fair rent in relation to the asset value of the property and the tenant's ability to pay.

Discounts could be offered, discretionary investments made, but "the most important thing is ensuring the right person is in the pub in the first place". An industry mantra if ever there was one.

Financing

Meanwhile, analysts point to the fact that compared with its peers Greene King was "relatively conservative" in its financing.

The group has no major repayments to make on its debt until 2012, the securitised element of which has risen from £1.1bn to £1.4bn following a recent refinancing.

News that the group believed it would be able to convert to real estate investment trust (REIT) status without having to sell off its managed operation was noted, but did not create the kind of sensation that such an announcement might have generated a year ago. Greene King plans to update the market on its REIT thoughts in December, at the time of its interim results.

Current trading, meanwhile, is unsurprisingly tough. Like-for-like pub sales in the first eight weeks of the new financial year were down 2.8 per cent - a figure described by one analyst as "encouraging", since this included tenanted estate profits in line with last year.