MARS top up

[TUK020]

Mars is in my list of top ups, and seems a good choice superficually.
However, I am a little unnerved by the steadily falling share price over a while.
What are folks opinions as to the dividend sustainability?

[JMN2]

On my permanent naughty step. All this ongoing grim trend for pubs, beer, smoking ban is having a permanent hindrance to the property side of the business, they should just develop the whole lot into flats and pay out and delist.

Probably my top "Carillion"candidate, I'll give it five years max.

[idpickering]

Mars is in my list of top ups, and seems a good choice superficually.
However, I am a little unnerved by the steadily falling share price over a while.
What are folks opinions as to the dividend sustainability?

Hi TUK020, I hold these, and am not concerned regarding the dividend. The cover is ok at 1.8 according to digitallook. I did double my bet on MARS on Monday by topping up my holdings, and as of now, they're my only FTSE250 share, and I have no intention of selling out

Ian.

[idpickering]

On my permanent naughty step. All this ongoing grim trend for pubs, beer, smoking ban is having a permanent hindrance to the property side of the business, they should just develop the whole lot into flats and pay out and delist.

Probably my top "Carillion"candidate, I'll give it five years max.

So you don't have mixed feelings regarding MARS then JMN2?

Ian.

[Walrus]

I believe Greene King have a trading update tomorrow, so that may give some further indication as to Q1 performance in the industry.

[idpickering]

I believe Greene King have a trading update tomorrow, so that may give some further indication as to Q1 performance in the industry.

Thanks for that Walrus. I'll be there, fingers poised.

Ian.

[tjh290633]

Although the pessimism about GNK seems to rub off into MARS, I feel that it is very overdone. I prefer to judge MARS by their own announcements, and their own strategy. I have as much of them as my limits will allow, and they are a very big contributor to my dividend income.

On a different tack, I see that Fuller's have taken over my favourite brewer, Dark Star, but intend to keep the brewery going as is. Perhaps analogous with the take over of Charles Wells by MARS, and contrary to GNK's method of increasing their pub estate, while closing the associated breweries.

TJH

[Walrus]

Although the pessimism about GNK seems to rub off into MARS, I feel that it is very overdone. I prefer to judge MARS by their own announcements, and their own strategy. I have as much of them as my limits will allow, and they are a very big contributor to my dividend income.

On a different tack, I see that Fuller's have taken over my favourite brewer, Dark Star, but intend to keep the brewery going as is. Perhaps analogous with the take over of Charles Wells by MARS, and contrary to GNK's method of increasing their pub estate, while closing the associated breweries.

TJH

I hadn't heard that. Darkstar is one of my favourite brews also being our local brewery, it's a shame Fullers don't have much of a yield!

Back to Marstons, I really like them as a value play and do hold them for much the same reasons, I think investing in the brands is a decent strategy and their ales for me are much better tasting than Greene King and I would suspect from personal experience have a loyal customer base. I also think with the world cup there is some decent upside, and potentially further consolidation.

To now I have held off including them in my own HYP though I do have them in my value portfolio as above purely on the basis of debt and that I'd actually prefer them to pay some of it down.

[Gengulphus]

On my permanent naughty step. All this ongoing grim trend for pubs, beer, smoking ban is having a permanent hindrance to the property side of the business, they should just develop the whole lot into flats and pay out and delist.

I'd say that whatever one thinks about whether they "should" do that, it's not something they can do. The issue is planning: to change a pub to residential use, they've got to get planning permission to do so - and planning policy is currently basically only to grant such permission if using the property as a pub has become commercially unviable.

The decline in popularity of pubs does mean (if it continues) that pubs are likely to gradually become less commercially viable and eventually not commercially viable, providing justification for their owners to change them over to residential use. But of course, each time that happens, the closed pub's clientele are likely to move to other local pubs, making them more commercially viable again. So while I do expect the pub companies to be able to slowly wind down their pub estates roughly in proportion to the decline in their market for as long as that decline continues, I don't expect them to be able to do a big-bang "just develop the whole lot into flats" exit from the pub market.

Probably my top "Carillion"candidate, I'll give it five years max.

I'll give it a lot more than that min! Basically, if the pub companies are on the way out, I think their exits will be with very prolonged whimpers, not bangs - and given the upgrade in property values when pubs are shifted to residential use, those whimpers should be quite lucrative...

Gengulphus

[spasmodicus]

Gengulphus wrote

JMN2 wrote:
Probably my top "Carillion"candidate, I'll give it five years max.

I'll give it a lot more than that min! Basically, if the pub companies are on the way out, I think their exits will be with very prolonged whimpers, not bangs - and given the upgrade in property values when pubs are shifted to residential use, those whimpers should be quite lucrative...

...unless other local councils follow Wandsworth's example
http://www.wandsworth.gov.uk/news/article/13477/wandsworth_council_protects_120_pubs_from_redevelopment

I hold both MARS and GNK, having bought them a year or two ago as "worthy" HYP candidates. However, their share prices have both fallen to the point where yields are now over 7%, which alarms me more than a little, if only because several historic high yielding shares have come unstuck at this level. cf the sometimes lamented TMF board's "Luni danger zone".

I hope that I'm wrong about this, but it does fuel my doubts about buy and forget HYP strategies. Strictly speaking, both these are near the bottom limit of market cap. for real pyad style HYP candidates. Not too big to fail?

holding, fingers crossed,
S
nevertheless, I like the products of both these companies

[Gengulphus]

Gengulphus wrote

JMN2 wrote:
Probably my top "Carillion"candidate, I'll give it five years max.

I'll give it a lot more than that min! Basically, if the pub companies are on the way out, I think their exits will be with very prolonged whimpers, not bangs - and given the upgrade in property values when pubs are shifted to residential use, those whimpers should be quite lucrative...

...unless other local councils follow Wandsworth's example
http://www.wandsworth.gov.uk/news/article/13477/wandsworth_council_protects_120_pubs_from_redevelopment

Unless??? My whole point is that the pub companies won't be allowed to change their pubs' use without getting planning permission, and that's what your link is saying - e.g. "But following Wandsworth Council’s ground breaking move all 120 pub owners affected will have to seek approval from the town hall before changing the building use or knocking it down", or from its contained Article 4 Directions link, "An Article 4 Direction does not prevent the development to which it applies, but instead requires that planning permission is first obtained from the Council for that development". I.e. your link is supporting what I said, not making an exception to it!

Or are you saying that you expect Wandsworth Council to be able to deny planning permission for any of the 120 pubs concerned to have their use changed, even if the demand for pubs continues to decline? I'm pretty certain that isn't the case: if the demand for pubs drops, then the number of them will be allowed to drop in proportion and so it will be possible for pub companies to close down pubs on a one-at-a-time basis and use the properties for other purposes or sell them off for residential (or other) development (and if councils try to insist on keeping them as pubs when there isn't enough demand to make them commercially viable, they'll find themselves on the losing side of lawsuits about them making unreasonable use of their powers). What won't be allowed is doing the same on a wholesale basis.

Gengulphus

[spasmodicus]

Gengulphus said

Or are you saying that you expect Wandsworth Council to be able to deny planning permission for any of the 120 pubs concerned to have their use changed, even if the demand for pubs continues to decline?

No, I'm just saying that flogging off pub sites for redevelopment, with change of use, won't be quite so easy in the future, one of the many factors affecting pub chain owner perceived value.

As many have said, the decline in MARS / GNK share prices over the last couple of years is symptomatic of falling consumer spending power. It remains to be seen whether this recovers in the bright new dawn we are promised after Brexit, when the UK economy will allegedly throw off the shackles of EU over-regulation etc etc.

I'm not much heartened by GNK's recent news "Pub operator and brewer Greene King said full year profit could fall 10-12% after pub sales worsened in the last few months of the year amid a continued "challenging" market." This resulted in a share price jump of about 10% - a dead or at least dying cat bounce perhaps, but then this is HYP and I'm not supposed to worry about that. Who knows, the pub business might recover in the longer term if people have to start paying for Facebook.

Still gritting my teeth and holding,
S

[westmoreland]

the pub sector is far too competitive to invest in IMO. this has driven returns down over time, and a quick calculation shows that MARS is making 5% ROIC, which is sub cost of capital.

interest wipes out 43% of the operating income, which leaves very little for shareholders.

[JMN2]

I understand there are planning laws in the UK and it can be a lengthy, difficult or impossible process, I just didn't find it necessary to footnote my every word with an explanation - my comment was meant more as a general "sweeping statement", sorry for that.

[scrumpyjack]

I have a fairly large holding of GNK at an average cost of 342p so certainly can't complain about their performance overall even though they have been a lot higher than the current 544p. They are a high quality company with generally a very good track record, apart from the occasional major cock up (like having a large share buy back at about £10 a share and then having to raise a similar total amount by rights issue at £2.70 a few years later! Tim Martin of Wetherspoons really had a laugh about that.)

They can sell underperforming pubs and keep the better performing ones, and fears of not getting change of use permission are overdone. There is huge pressure on Local Authorities to increase the stock of housing and I doubt they can force a loss making pub to keep going.

I certainly wouldn't sell at the current price, even after the bounce back, and am quietly amused at the smell of burnt shorters!

[Gengulphus]

I understand there are planning laws in the UK and it can be a lengthy, difficult or impossible process, I just didn't find it necessary to footnote my every word with an explanation - my comment was meant more as a general "sweeping statement", sorry for that.

It isn't necessary to footnote your every word with an explanation - it would be sufficient for you simply to avoid making suggestions that you know are impractical, like "they should just develop the whole lot into flats and pay out and delist". If you make them nevertheless, expect people to assume that you don't know that they're impractical and explain why they are - readers can only read your words and their implications, not your mind! And in any case, quite possibly other readers don't know why the suggestion is impractical, so even if the explanation is of no value to you, that doesn't necessarily mean it's of no value.

Gengulphus

[Gengulphus]

I have a fairly large holding of GNK at an average cost of 342p so certainly can't complain about their performance overall even though they have been a lot higher than the current 544p. They are a high quality company with generally a very good track record, apart from the occasional major cock up (like having a large share buy back at about £10 a share and then having to raise a similar total amount by rights issue at £2.70 a few years later! Tim Martin of Wetherspoons really had a laugh about that.)

Although that laughter may be justified to some extent, I think it's a much lesser extent than the facts as you've stated them suggest.

The biggest reason is that the need for the extra capital had appeared as a result of the financial crisis, probably very unexpectedly. The company does not appear to have got itself into any sort of trouble - rather, it wanted to take advantage of opportunities that had arisen as a result of the crisis. This is apparent in the reasons given for the rights issue:

Rights Issue to raise approximately £207.5 million, net of expenses, through the issue of 80,749,647 New Shares at a price of 270 pence per share, in order to enable Greene King to:

• make selective acquisitions at attractive prices of freehold, retail pubs in the Home Counties, London and Scotland; and

• repurchase some of Greene King's securitised debt at significantly below par value to take advantage of the current credit market conditions whilst at the same time further strengthening its financial position.

Those reasons do indeed appear to be genuine: the company's 2010 and later annual reports, which cover the period from May 2009 (when the rights issue happened) onwards, report acquiring quite substantial numbers of pubs, and the 2010 report says "As well as purchasing pubs as
outlined above, we also repurchased £30.3m aggregate principal amount of bonds, at a weighted average purchase price of £524 per £1,000." That's around a £14m profit - not to be sneezed at.

The earlier buybacks are reported in the company's 2007 and 2008 annual reports, covering roughly the two years from May 2006 to April 2008 (and about 5/6ths of them happened in the second of those two years); a more detailed look for "Transaction in Own Shares" RNSes indicates that the last of them happened on December 21st, 2007 (reported in an RNS on the 24th). At that time, I'm pretty certain the financial crisis was very hard to see coming. There might have been some signs of it coming if one knew exactly what to look for, but if so, few will have spotted them and I doubt even those who did will have had any real idea of its severity. (As an indication, even half a year later when it was much closer and there were much less obscure signs of it, they were still obscure enough that more than half of the HYP board readers who voted about GDHYP's first purchase chose Lloyds out of 10 candidates and I didn't veto it - see https://web.archive.org/web/20161119091 ... sort=whole.)

The point of all that is: without the benefit of hindsight, what alternatives did the Greene King directors have to your so-called "major cock up" at the time they made the decisions? At the time they decided to do the buybacks, they had a pile of cash and almost certainly a number of fund managers and other major shareholders demanding "either show us a foreseeable need the company has for the cash or return it to shareholders" - and I do mean demanding, not just requesting: a sufficient majority of major shareholders can get their way, if necessary by replacing directors, and so sensible directors give way to their demands rather than making an issue of them if they cannot give good reasons why they shouldn't! In the absence of a foreseeable need - and I don't think the fact that bargains would be available on pubs and the company's own debt was foreseeable, even if it was only about a couple of years away - they wouldn't have had any real alternative to returning the cash to shareholders. And however they returned it, when the financial crisis did happen and the bargains appeared, they would have had to do a rights issue or other fundraising to take advantage of them, and that would almost certainly have involved issuing more shares at the comparatively low prices they had dropped to, since the "credit crunch" aspect of the financial crisis had made raising extra funds by issuing debt very difficult.

So basically, I think circumstances and the shareholders themselves basically forced the Greene King directors to return cash to shareholders at a time when the share price was high, and to raise funds by issuing more shares at a time when the share price was low. One can argue about whether the share buybacks they chose were the best way to return the cash, and indeed about whether a rights issue was the best way to raise funds, but while I think the buybacks were a poor choice, I don't think they were so bad as to merit a "major cock up" description.

In short, IMHO most of the "major cock up" was stuff that the directors had no choice about in practice, and what's left merely made its effects a bit more severe rather than making a difference between whether it was major or not.

Another contributory factor towards the "major cock up" not being as bad as the facts you've stated suggest is the standard one for rights issues: shareholders did not get the new shares from the rights issue for £2.70 per new share. They got them for £2.70 plus a right per new share. About 17-20% of the value of the existing shares had been split off into the rights when they went ex-rights (*), and shareholders will always have got that value back, in one of three ways:

* Using them as part payment for the new shares, with a right worth about (5/3 because it took that number of original shares to get a right) * (say 18.5% as the proportion of the original shares' value that went into the rights) * (566p as the last value of the original shares before the rights were split off) = about £1.75 - which is roughly the difference between the £2.70 cash they needed to pay and the market value of a post-rights-issue share.

* Selling the rights on the market, which would have got between about £1.37 and £1.90 per right depending on how well-timed the sale was - less trading costs, of course.

* Letting the rights lapse, which will have resulted in a lapsed-rights payment of a bit under £1.70 per lapsed right (see https://www.investegate.co.uk/greene-ki ... 01480087T/).

Put another way, from a shareholder's perspective, the rights issue was more-or-less equivalent to somewhere around a 5-becomes-6 or 4-becomes-5 share split (which would have dropped the share price from its cum-rights level of about 566p to somewhere in the region of 4/5ths to 5/6ths of that = 453p to 472p), plus letting a proportion of them go at somewhere around that price, plus the opportunity to buy some extra shares at around that price. And from the company perspective, it's also more-or-less equivalent to that, without the complicating factors of the individual shareholders' decisions (since the company got the £2.70 per new share regardless of those decisions) - i.e. to a roughly 5-becomes-6 or 4-becomes-5 share split, increasing the number of shares in issue by a factor of around 1.20-1.25, and then issuing about 30% more shares at the post-split market price on top of that (for an overall increase of shares in issue by about a factor of (1.2 to 1.25) * 1.3 = 1.56 to 1.625 - the actual increase from the rights issue was by a factor of 1.6). And the company did in fact treat it as though it had been done that way in many respects - for example, a share split that increased the number of shares in issue by a factor of 1.2 to 1.25 would have decreased dividends per share by a factor of 1/1.25 = 0.80 to 1/1.2 = 0.83 without decreasing shareholder income, and the 'bonus element' adjustment to previous dividends that the company applied for comparative purposes was to decrease them by a factor of about 0.81.

So you might ask why the company didn't do the fundraising that way, with a suitable share split followed by issuing about 30% extra shares at the post-split share price, or indeed just issue about 30% extra shares at the pre-split share price without doing the share split at all? Those methods would have been simpler to think about than the rights issue, and the second would have been simpler overall... But unfortunately, issuing 30% extra shares in an existing company at the current share price is by no means guaranteed to find takers - indeed, it's more-or-less guaranteed not to find many in normal circumstances - and getting an underwriter to guarantee that they'll take any shares at the current market price that no-one else will take would be prohibitively expensive. I.e. the complications of, and resulting somewhat contorted thinking required by, rights issues as a method of fundraising are part of the price we pay for companies being able to guarantee that they'll get the funds they want with a rights issue by getting it underwritten (**).

So to sum up, Greene King paid around £10 per pre-rights issue share in 2006/2007, but that's only the equivalent of about £8 per post-rights issue share. And from both shareholders' and the company's perspectives, the rights issue was more-or-less equivalent to a share split by a rather unusual split ratio, which accounted for some of the increase in the shares in issue, plus issuing a smaller number of extra shares at market value of say £4.40 per share. So while the rights issue fundraising was indeed done at a considerably lower value per share than the share buyback return of cash a few years earlier, a fair assessment was that it was done at a bit over half the value per share (£4.40 compared with £8) rather than a bit over a quarter of the value per shares as suggested by the £2.70 and £10 figures. The combination of the two certainly wasn't good for shareholders, but a lot of it was IMHO probably stuff the Greene King directors had no real choice about, with both some sort of return of cash in 2006/2007 and some sort of fundraising in 2009 being pretty much forced.

As a final note, I would certainly have preferred the return of cash in 2006/2007 to have been by special dividend rather than share buybacks (I don't have any quarrel with the fundraising being by rights issue - the practical alternatives I know of would IMHO have been worse). But I have to face the fact that if I had received a large special dividend from my HYP in say 2007, I would almost certainly have reinvested it in extra shares for my HYP and it would probably only have been worth about 2/3rds as much by May/June 2009 (judging by what the FTSE 100 did over that sort of period), or a bit more for the dividends earned on those shares. I.e. if the Greene King directors had done the return of cash and the fundraising by the methods I would have preferred, I would probably have ended up with about 70% of the amount of cash returned rather than about 55% of it. Not good, but nothing like as bad as the 100% vs 27% suggested by the £10 and £2.70 figures.

(*) This is visible in historical share prices - 566p at the close on 12/05/2009 just before the rights were split off, 460p on opening on 13/05/2009. I don't have a market value for the rights on 13/05/2009, but they will have been worth pretty close to 270p less than a share (otherwise arbitrageurs would have been able to make a risk-free profit either by going long on the rights and correspondingly short on the shares, or vice versa), so somewhere close to 190p per right when opening on 13/05/2009. And per 5 shares owned by a shareholder and worth 5*566p = 2830p at the close on 12/05/2009, they would have owned 5 shares and 3 rights worth about 5*460p + 3*190p = 2870p on opening on 13/05/2009 - a slight overnight rise, but nothing particularly unusual (and it didn't last long - the share price fell to a close of 424p, and the rights will similarly have fallen to about 154p, by the close on that day). More generally, the share price varied between 406.75p and 460p during the period during which the rights were tradeable, which corresponds to 3 rights making up between about (3*136.75p)/(5*406.75p+3*136.75p) = 16.8% and (3*190p)/(5*460p+3*190p) = 19.9%. That's what shareholders who sold their rights would have got; shareholders who neither took them up nor sold them will have got a lapsed-rights payment of 440p - 270p - company's trading costs = a bit less than 170p per lapsed right, meaning that for them, pretty close to (3*170p)/(5*440p+3*170p) = 18.8% of the original holding's value had gone into the rights.

(**) Note that the "discount" of a rights issue is not a significant incentive for shareholders - the right that needs to be used up to get a new share will be worth about the difference between the market price of an ex-rights share and the subscription price. It's actually an underwriter incentive - the subscription price is basically the level at which underwriters guarantee to step in and take the new shares if the share price drops catastrophically and nobody wants to take up the rights because, should they want the shares at all, they can get them more cheaply by buying them on the market than by taking up rights. So what a greater discount actually indicates is not a better bargain for shareholders, but that underwriters consider the shares more risky and so want a greater incentive to underwrite the rights issue at their usual only-halfway-unreasonable fee. I.e. a bigger discount for a rights issue is a bigger-than-usual indication of riskiness for shareholders and thus (if anything) an argument against taking it up, not the bigger-than-usual reason to take it up it is often taken to be!

Gengulphus

[scrumpyjack]

Sorry I really don't see it that way. Competent management can easily say no, and must do so, to investment bankers telling them to do something management do not think is prudent or desirable. I recall many decades ago a company I had intimate knowledge of was told behind the scenes by its Investment Bank (Schroders) to change their Chairman. The board quietly told Schroders it would be easier to change investment bankers. Nothing more was heard on the subject from Schroders!

Having a share buy back when the share price is at all time highs and at prices way above net asset value is not sensible or prudent. Managing net asset value and property backing is a key part of running a pub company.

If they did want to return some surplus cash at that stage it would have been better to do it by special dividend or capital return with shareholders having the choice. At that time there was no problem doing the old B/C share scheme. At least then the recipients of the largess would be the continuing shareholders equally.

No I share Tim Martins view of it and it was not simply bad luck.

[Gengulphus]

Sorry I really don't see it that way. Competent management can easily say no, and must do so, to investment bankers telling them to do something management do not think is prudent or desirable. I recall many decades ago a company I had intimate knowledge of was told behind the scenes by its Investment Bank (Schroders) to change their Chairman. The board quietly told Schroders it would be easier to change investment bankers. Nothing more was heard on the subject from Schroders!

Having a share buy back when the share price is at all time highs and at prices way above net asset value is not sensible or prudent. Managing net asset value and property backing is a key part of running a pub company.

If they did want to return some surplus cash at that stage it would have been better to do it by special dividend or capital return with shareholders having the choice. At that time there was no problem doing the old B/C share scheme. At least then the recipients of the largess would be the continuing shareholders equally.

No I share Tim Martins view of it and it was not simply bad luck.

I don't think you're actually disagreeing with me. I didn't say that a share buyback was sensible: on the contrary, I said that I would have preferred the return of cash to be by a special dividend. I didn't add to an already-long reply by mentioning B/C share schemes, but they would have been a nearly-as-good alternative as far as I was concerned, and one I would have found perfectly acceptable on the basis that other shareholders are entitled to have their preferences taken into account - I don't expect every company decision to be purely driven by what I would prefer!

And I said "fund managers and other major shareholders", not "investment banker". The directors of a company can easily tell its investment banker that it would be easier to change investment bankers, as you suggest - but telling its major shareholders that it would be easier to change major shareholders would not be a good move! The likely reaction would be that the major shareholders would decide (a) that the directors concerned had lost touch with reality; (b) that it was easier for the major shareholders to decide to change directors than vice versa...

And I didn't say that it was simply bad luck. I said that the £10 vs £2.70 figures made it look considerably worse than it was. Those figures are IMHO due to a combination of three elements:

* a common misunderstanding about the subscription price of rights issues, due to the mechanics of rights issues implicitly (but not explicitly) having a 'share split' element to them;

* the bad luck of the financial crisis generating a very unexpected need for cash a fairly short time after the company had returned cash to shareholders, cash that had not been foreseeably needed at the time;

* a poor choice of buybacks as the cash return mechanism.

Each of the three makes a considerable contribution to the £10 vs £2.70 contrast, so that contrast ends up considerably bigger than any of them individually explains. So explaining it as simply bad luck considerably exaggerates the role of bad luck in that contrast, but equally, explaining it as simply due to decisions made by the directors considerably exaggerates the role of director choices in that contrast, given that IMHO the directors only had a real choice about the third of them. (And to be clear, I'm not saying you tried to explain it as simply due to decisions made by the directors - you didn't. Rather, you presented the contrast as a laughable part of their track record and left people to draw their own conclusions about its explanation. Much of reason for posting is to point out to everyone that drawing fair conclusions from it is considerably more complicated than it at first sight appears...)

Gengulphus