Healthy H1

Greggs 3 August 2016 Update

Greggs

Healthy H1

Interim results

Retail

3 August 2016

Price

1,049p

Market cap

£1,062m

Net cash (£m) at 2 July 2016

35

Shares in issue

101.2m

Free float

100%

Code

GRG

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

6.3

1.6

(20.5)

Rel (local)

4.7

(3.8)

(19.7)

52-week high/low

1,320p

884p

Business description

With over 1,730 shops, nine regional bakeries and 19,500 employees, Greggs is the UK’s leading ‘bakery food-on-the-go’ retailer. It utilises vertical integration to offer differentiated products at competitive prices.

Next events

Trading update

October 2016

Analysts

David Stoddart

+44 (0)20 3077 5700

Paul Hickman

+44 (0)20 3681 2501

Greggs is a research client of Edison Investment Research Limited

Greggs delivered a strong H116 trading performance and expressed confidence in the outlook for the year. The various elements of its strategy appear to be on track and have so far delivered the expected benefits. This reinforces confidence in the longer-term potential for the brand. Meanwhile it remains strongly financed and highly cash-generative. Our DCF valuation has increased by 2% to 1,179p.

Year
end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/14

806.1

58.3

44.0

22.0

23.8

2.1

12/15

835.7

73.0

57.3

28.6

18.3

2.7

12/16e

877.8

77.2

60.2

29.9

17.4

2.9

12/17e

932.8

84.0

65.4

32.7

16.0

3.1

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

A strong H116

Within total H1 sales growth of 6.0%, Greggs delivered like-for-like (LFL) sales growth of 3.8%, which is impressive against 5.8% LFL growth in H115. Continuing deflation in ingredient and packaging costs saw the H1 gross margin improve by 40bps. The introduction of the National Living Wage in Q2 led to some pressure on operating costs but Greggs maintained its operating margin before property and exceptional charges. Despite a small net cash outflow, Greggs ended H1 with net cash of £35m.

Strategic initiatives delivering as expected

The sales figures confirm that the focus on product and range development are paying off. Refurbishments continue to contribute to LFL sales growth and the store opening pipeline has improved. The plan to transform logistics and manufacturing are on schedule. The Sleaford bakery has already closed and the Twickenham unit will follow in Q416 when the new Enfield facility is ready. Greggs has planning permission to develop its Glasgow bakery, which will allow the final bakery slated for closure, Edinburgh, to close in 2017. The implementation of the SAP finance module during H1 was successful, which bodes well for the next phases of the systems development.

Valuation: Premium rating warranted

Our FY16 estimates have changed only immaterially. We have, however, trimmed our FY17 estimates to reflect a smaller revenue contribution from new space that results from the phasing of openings. We have reverted to a DCF analysis to value Greggs. Our new valuation of 1,179p is slightly higher than our multiple-derived 1,169p of May. That price would value the shares more highly than sector averages, but given the strength of Greggs’s track record, its financial strength, underlying growth in the food-to-go market, scope to increase store numbers substantially and the longer-term potential in extending the trading day further, a premium rating is appropriate.

Interim results show Greggs on track

Greggs summarises its interim results as “in line with our plans”. In its outlook statement it notes that “we expect to deliver full-year growth in line with our previous expectations as well as further progress against our strategic plan”. In short, a strong H116 and good start to H216 position Greggs well to meet our FY16 estimates.

Exhibit 1: Summary interim income statement

H116

H115

% change

£m

£m

Sales

422.1

398.4

6.0%

Operating profit before property and exceptional items

27.2

25.5

6.7%

Property disposal gains

2.2

0.1

EBIT before exceptionals

29.4

25.6

14.9%

Net exceptional charge

(4.0)

0.0

Finance income

0.0

0.0

Profit before taxation

25.4

25.6

-0.8%

Source: Greggs, Edison Investment Research

Strong trading delivers H116 profit growth

Total sales for the 26 weeks to 2 July 2016 grew by 6.0% to £422m, with LFL sales in company-managed shops up by 3.8%, against a tough comparison of 5.8%. Greggs recorded increases in both customer numbers and average transaction values. Once again, the refurbishment programme contributed c 1pp to LFL growth and there was a small contribution from additional trading hours, especially in the morning. Marketing support was broadly unchanged during H1.

Total sales growth has several origins. First, Greggs continues its product innovation: by way of example, the Balanced Choice healthier options range increased sales “strongly” in H1. Greggs extended its coffee range and invested in improved service to meet continued growth in coffee sales. Breakfast remains the fastest-growing day-part in the business, reflecting wider market trends and benefiting as the offer evolves. Second, Greggs continues to emphasise its value credentials through its ‘value’ offers. Additional loyalty benefits from its relaunched Greggs Rewards app enhance that value message. Third, Greggs continues to refurbish the tail of its estate in its latest ‘bakery food-on-the-go’ format wherever appropriate, improving the customer offer in those units. It refurbished 86 stores in H1 and remains on target to update 200 outlets. Fourth, Greggs has stepped up its store opening programme. It opened 68 shops in H1 while closing 36 to give a net addition of 32. At the end of H1, Greggs traded from 1,730 shops, of which 136 are franchised, including 31 opened in H1.

H1 gross margin increased by 40bps as food and packaging input costs continued to be deflationary. Operating expense declined as a percentage of sales, partly in response to the operational leverage benefits of LFL sales growth and partly reflecting the benefits of the systems and process investments made as part of the strategic plan. That said, the impact of the National Living Wage was not felt until Q2, at which point it applied pressure to store costs as reflected in the increased proportion of H1 sales represented by selling and distribution costs.

Property disposal gains have been a regular feature of Greggs’ income statements over the years. There was an unusually large gain of £2.2m in H1 following the sale of the previous head office in Jesmond, Newcastle and a London store.

Exhibit 2: Analysis of operating margin

H116

H115

Sales £m

422.1

398.4

Gross margin

63.2%

62.8%

Distribution & selling costs

-50.8%

-50.7%

Admin expenses

-6.0%

-5.7%

EBIT before property and exceptional items

6.4%

6.4%

Property disposal gains

0.5%

0.0%

EBIT pre-exceptional items £m

29.4

25.6

Operating margin

6.9%

6.4%

Source: Greggs, Edison Investment Research

Strategic initiatives also on track

The strategic plan to transform and develop the supply chain is on track. The new distribution facility in Enfield should be operational in October, allowing the closure of the existing Twickenham bakery in Q4 as planned. In addition, Greggs has secured planning permission for the extension of its Glasgow bakery, which will allow closure of the Edinburgh bakery during H217, as previously announced. Management is therefore now able to plan the next phase of investment in its remaining sites, which is designed to increase logistics capacity and consolidate manufacturing to create centres of excellence, with benefits in product quality, consistency and efficiency.

In April this year Greggs implemented SAP to handle its core finance processes. Reassuringly, that implementation went well and provides the base on which management will build enhanced capabilities across logistics, procurement, product lifecycle management and centralised ranging, forecasting and replenishment. Greggs intends to trial improved shop-stock-replenishment processes in H2 as previously planned.

Exceptional items

Greggs indicated at its preliminary results in March that it would incur exceptional charges of c £7m this year in connection with the supply chain transformation plans. The initial phase of this plan involves the closure of three bakeries with associated one-off costs now advised to be £7.6m. £4.8m of this cost was recognised in H1 and this, combined with a £0.8m release of historical shop closure provisions, resulted in a net exceptional charge of £4.0m in the period. Greggs expects the overall cost and exceptional charges arising from the plan to be in line with previous guidance.

H1 cash outflow

Greggs increased cash flow from operations from £34.6m in H115 to £44.7m in H116. Nevertheless, there was a net cash outflow of £7.9m during H116 (H115: £2.3m). Capex plus investment in intangible assets totalled £31.2m, £0.1m lower than in the comparable period. The larger outflow resulted from a c 32% increase in dividend payments and an increase in share purchases. Nevertheless, Greggs ended H1 with £35m of net cash and generated net interest income, albeit of only £16k in H1.


Estimates

Our FY16 estimates have changed only immaterially, although their structure is a little different to that in our May note. Although Greggs will open a net 70 stores this year, it describes the opening programme as ‘back-end-weighted’. That being so, we have edged down the sales contribution that we expect from new space. Our new revenue estimate is c £4m below its predecessor. Our gross margin assumption remains unchanged. There may be some input cost pressure later in H2 following sterling’s recent decline that might reverse some of the recent deflation in product input costs. However, this will depend on other factors applying at the time that Greggs comes to negotiate fresh terms on ingredients. Meanwhile, with coffee (above-average gross margin) being the fastest growing product, there is a mix benefit to gross margin.

We model a 10bps reduction in the EBITDA margin versus our previous expectation, reflecting the impact of the reduced sales growth estimate.

Greggs is maintaining guidance that FY16e capital investment will be c £85m. That leaves c £54m to be invested in H2. Nevertheless, we model a net cash inflow during H2: it is seasonally the stronger half for EBITDA and we model a working capital inflow.

Despite the sharp increase in the interim dividend from 7.4p to 9.5p, we are leaving our full-year dividend estimate unchanged. Greggs is seeking to re-balance the annual dividend in favour of the interim but still targets full-year dividend cover of 2x.

We have reduced our FY17 PBT forecast from £84.8m to £84.0m. The major driver in the change is lower revenue, partly reflecting the base effects of our reduced FY16e revenue estimate but also assuming a smaller contribution from new space in FY17e. At this stage, we maintain our assumption of maintained gross margins. This will depend upon further currency moves, changes to underlying commodity prices, retail pricing, production efficiencies, wastage rates and sales mix, among other factors. A small change in our depreciation assumption results in an FY17e EBITDA margin that is 10bps higher than our previous estimate, but our operating margin estimate remains unchanged.

We summarise the changes to our forecasts below.

Exhibit 3: Summary of estimate changes

EPS (p)

PBT (£m)

EBITDA (£m)

Old

New

% chg.

Old

New

% chg.

Old

New

% chg.

2016e

60.4

60.2

-0.4%

77.1

77.2

0.1%

122.0

120.2

-1.5%

2017e

66.5

65.4

-1.6%

84.8

84.0

-0.9%

132.3

132.0

-0.2%

Source: Edison Investment Research


Valuation

We have again valued Greggs using DCF techniques. Since our previous DCF valuation, risk-free rates have fallen again. On the other hand, Greggs’ beta coefficient has increased slightly. Nevertheless, despite the small reduction in PBT estimate for FY17, our valuation has edged up from our 1158p DCF valuation in April and multiple-derived 1,169p in May to 1,179p. The following table shows the sensitivity of that valuation to changes in the cost of capital and the multiple that we apply to terminal post-tax cash flows. Our base case terminal multiple is 8, which we regard as conservative in the prevailing interest-rate environment.

Exhibit 4: Sensitivity of valuation to cost of capital and terminal multiple

4.3%

4.6%

4.9%

5.2%

5.5%

5.8%

6.1%

7.0x

1,166

1,141

1,117

1,094

1,071

1,049

1,027

7.5x

1,199

1,173

1,148

1,124

1,100

1,077

1,055

8.0x

1,232

1,205

1,179

1,154

1,129

1,105

1,082

8.5x

1,266

1,238

1,210

1,184

1,159

1,134

1,110

9.0x

1,299

1,270

1,242

1,214

1,188

1,162

1,137

9.5x

1,332

1,302

1,273

1,244

1,217

1,190

1,164

10.0x

1,365

1,334

1,304

1,274

1,246

1,219

1,192

Source: Edison Investment Research

In the context of sector valuations, a price of 1,179p would appear a full valuation. Exhibit 5 summarises the resulting valuation metrics. However, given the strength of Greggs’ track record, its financial strength, underlying growth in the food-to-go market, scope to increase store numbers substantially and the longer-term potential in extending the trading day further, a premium rating is appropriate.

Exhibit 5: Valuation metrics at 1,179p

P/E (x)

Yield (%)

EV/EBITDA (x)

2016e

19.8

2.5

10.0

2017e

18.2

2.7

9.1

Source: Edison Investment Research

Exhibit 6: Financial summary

£m

2013

2014

2015

2016e

2017e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

762.4

806.1

835.7

877.8

932.8

Cost of Sales

(305.9)

(304.8)

(305.1)

(319.2)

(339.1)

Gross Profit

456.5

501.3

530.6

558.7

593.7

EBITDA

 

 

74.9

95.6

113.3

120.2

132.0

Operating Profit (before amort. and except.)

41.5

58.1

73.1

77.2

84.0

Intangible Amortisation

0.0

0.0

0.0

0.0

0.0

Exceptionals

(8.1)

(8.5)

0.0

(7.6)

0.0

Other

0.0

0.0

0.0

0.0

0.0

Operating Profit

33.4

49.6

73.1

69.6

84.0

Net Interest

(0.2)

0.2

(0.1)

0.0

0.0

Profit Before Tax (norm)

 

 

41.3

58.3

73.0

77.2

84.0

Profit Before Tax (FRS 3)

 

 

33.2

49.7

73.0

69.6

84.0

Tax

(10.3)

(14.0)

(15.4)

(16.8)

(18.2)

Profit After Tax (norm)

30.9

44.3

57.6

60.4

65.8

Profit After Tax (FRS 3)

24.2

37.6

57.6

54.6

65.8

Average Number of Shares Outstanding (m)

100.4

100.5

100.6

100.5

100.5

EPS - normalised (p)

 

 

30.8

44.0

57.3

60.2

65.4

EPS - normalised and fully diluted (p)

 

30.5

43.4

55.8

58.9

64.0

EPS - (IFRS) (p)

 

 

24.1

37.4

57.3

54.3

65.4

Dividend per share (p)

19.5

22.0

28.6

29.9

32.7

Gross Margin (%)

59.9

62.2

63.5

63.6

63.6

EBITDA Margin (%)

9.8

11.9

13.6

13.7

14.2

Operating Margin (before GW and except.) (%)

5.4

7.2

8.7

8.8

9.0

BALANCE SHEET

Fixed Assets

 

 

268.9

267.4

298.2

326.8

353.8

Intangible Assets

1.0

4.7

10.2

15.6

20.3

Tangible Assets

267.8

262.7

284.2

307.1

329.4

Investments

0.1

0.0

3.8

4.0

4.0

Current Assets

 

 

65.0

101.5

86.0

87.5

102.6

Stocks

15.4

15.3

15.4

16.0

17.0

Debtors

25.0

26.1

27.6

27.5

29.3

Cash

21.6

43.6

42.9

44.0

56.2

Other

3.0

16.5

0.0

0.0

0.0

Current Liabilities

 

 

(80.7)

(102.1)

(106.0)

(113.9)

(118.5)

Creditors

(80.7)

(102.1)

(106.0)

(113.9)

(118.5)

Short term borrowings

0.0

0.0

0.0

0.0

0.0

Long Term Liabilities

 

 

(17.0)

(20.1)

(11.9)

(26.7)

(24.9)

Long term borrowings

0.0

0.0

0.0

0.0

0.0

Other long term liabilities

(17.0)

(20.1)

(11.9)

(26.7)

(24.9)

Net Assets

 

 

236.2

246.7

266.3

273.7

312.9

CASH FLOW

Operating Cash Flow

 

 

82.5

108.6

119.6

123.9

136.0

Net Interest

(0.0)

0.2

0.2

0.1

0.0

Tax

(13.2)

(11.5)

(15.9)

(16.9)

(18.2)

Capex

(48.6)

(48.3)

(71.8)

(85.0)

(75.0)

Acquisitions/disposals

0.2

(4.8)

18.1

13.9

0.0

Financing

0.9

(2.6)

(7.2)

(4.1)

(0.0)

Dividends

(19.6)

(19.6)

(43.7)

(30.9)

(30.6)

Net Cash Flow

2.2

22.0

(0.7)

1.0

12.3

Opening net debt/(cash)

 

 

(19.4)

(21.6)

(43.6)

(42.9)

(44.0)

HP finance leases initiated

0.0

0.0

0.0

0.0

0.0

Other

0.0

(0.0)

0.0

0.0

0.0

Closing net debt/(cash)

 

 

(21.6)

(43.6)

(42.9)

(44.0)

(56.2)

Source: Greggs accounts, Edison Investment Research

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt, Sydney and Wellington. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

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