In balance

Greggs 9 August 2017 Update
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Greggs

In balance

Interim results

Retail

9 August 2017

Price

1,118p

Market cap

£1,131m

Net cash (£m) at end June 2017

19.9

Shares in issue

101.2m

Free float

100%

Code

GRG

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

4.5

3.5

6.7

Rel (local)

1.8

0.6

(4.4)

52-week high/low

1,129.0p

901.5p

Business description

With over 1,800 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

3 October 2017 (provisional)

Analysts

Paul Hickman

+44 (0)20 3681 2501

Neil Shah

+44 (0)20 3077 5715

Greggs is a research client of Edison Investment Research Limited

Greggs’ interims show a company in balance in several ways. First, operational and site development initiatives are driving consistent sales growth despite a challenging market. Second, the balance between low-price value and perceived quality is allowing it to cover peak input cost increases without a serious impact on margins. Third, the financial model is operating to support the dividend with a stable balance sheet.

Year
end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/15

835.7

73.0

57.3

28.6

19.5

2.6

12/16

894.2

80.3

62.0

31.0

18.0

2.8

12/17e

959.4

80.8

63.6

32.8

17.6

2.9

12/18e

1,028.4

83.9

66.6

34.8

16.8

3.1

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

Reassuringly good trading in the first half

Total sales grew 7.3%, and like-for-like sales grew 3.4%, comparing well against FY16. Operating profit pre-exceptionals and property profit, at £27.6m, was slightly ahead of H116, against flat guidance for FY17. Gross margin improved 10bp over a year ago, reflecting successful pricing and menu mix action counteracting peak ingredient inflation of 7%. Overall, pre-exceptional operating profit was only down 5% at £27.9m because of last year’s abnormal property gains.

Food on the go finds acceptance

Greggs’ continued sales growth suggests its blend of quality and value is going down well with price-conscious consumers. The company reports increasing demand for its hot sandwich, breakfast and coffee offers, as well as its traditional ranges of savoury foods.

Operational activity continues

In the half, another planned bakery closure was completed and a consolidated production initiative was initiated. But the period was dominated by Greggs’ biggest operational change ever, the system-wide roll-out of its central stock forecasting and replenishment system. Despite some initial costs, stock availability benefits are already being seen.

Food on the go has legs

Greggs has opportunities in new locations, including areas of the country where it is not represented. It is progressing in moving its location base off the high street, and is now being invited into shopping developments by landlords. In terms of dayparts, with new formats such as drive-through and transport hubs, there is no reason why Greggs should not eventually expand into the evening market.

Valuation: No change

Guidance is unchanged for the year, and we are not materially changing our forecasts. Consistent with that, we retain our valuation of 1,226p per share.

Interim results: Growth and development continue

Greggs has reported good trading progress in the first half year, indicating that its strategy is working successfully.

Total sales of £452.9m grew by 7.3%, which compares well against 2016 full-year growth of 7.0%, and like-for-like sales grew 3.4% against 4.2% in FY16. Management feels that, with the majority of its stores now trading under a food-on-the-go format, underlying sales growth has settled into a range of between 3% and 4%, with external conditions including weather responsible for variations within that.

The company reports continuing development of its chosen market of food-on-the-go, and is progressively less dependent on traditional shopping locations, giving it the potential to decouple from general retail weakness. Greggs reports increasing demand for its hot sandwich range and continued growth in its breakfast and coffee offers, as well as in its traditional ranges of savoury foods.

Operating profit before exceptionals and property gains, at £27.6m, was slightly ahead of last year. This is better than guidance for FY17 as a whole, which was for a flat performance.

Exhibit 1: Group sales and profit

£m

H117

H116

Change

Sales

452.9

422.0

7.3%

Operating profit before property and exceptional items

27.6

27.2

1.8%

Property disposal gains

0.3

2.2

EBIT before exceptionals

27.9

29.4

-5.1%

Net exceptional charge

(8.3)

(4.0)

Finance income

(0.1)

0.0

Profit before taxation

19.4

25.4

-23.7%

Source: Greggs

Despite that slight over performance, management regards trading as being on expectation and the outlook for the year is unchanged.

Greggs’ continued sales growth suggests that its blend of quality and value is going down well with price-conscious consumers. In addition, gross margin has improved 10bp over a year ago, which reflects some pricing and menu mix action to counteract ingredient costs, which increased 7% in the first half. That increase was driven by dairy and protein products and is likely to be a peak, with forward cover over food costs giving visibility of food inflation for the full year of between 6% and 7%.

Distribution and selling costs as a percentage of sales rose by 70bp, with wage inflation running at 3.3% and the Apprenticeship Levy, introduced in April, adding around a further 0.3% to the wage bill, we estimate. After some reductions in administrative costs, which rose in H116 on systems implementations, EBIT margin before property and exceptionals was down 30bp at 6.1%.

Exhibit 2: Margin analysis

H117

H116

Sales, £m

452.9

422.0

Gross margin

63.3%

63.2%

Distribution & selling costs

-51.5%

-50.8%

Admin expenses

-5.7%

-6.0%

EBIT before property and exceptional items

6.1%

6.4%

Property disposal gains

0.1%

0.5%

EBIT pre-exceptional items, £m

27.9

29.4

Operating margin

6.2%

6.9%

Source: Greggs

Property disposal gains of £2.2m in H116, which were abnormally large, were the main reason for pre-exceptional EBIT of £27.9m being 5% lower than last year.

Exceptionals and restructuring

Net exceptionals amounted to £8.3m in the first half. These form part of the previously flagged £100m multi-year change programme to reshape the manufacturing and logistics operations within Greggs. The major element of that consisted of unavoidable redundancy costs of £7.4m with asset-related and other costs and credits forming the balance. The planned closure of the Edinburgh bakery site was completed in April, with production and logistics activities transferred to Glasgow. Greggs has invested in the Glasgow site with additional work being located there, including the first consolidated manufacturing platform for the production of Yum Yums. In the second half a further consolidated manufacturing operation for cakes and muffins is planned to open in Leeds.

Cash flow and balance sheet

Net cash from operating activities was £34.0m, down from £44.8m at the same stage last year, the main factor being a £13m increase in working capital. This was mainly a result of changes to the supply chain in FY16. Capex of £36.4m was £5m higher than H116 on increased supply chain investment and an increased number of shop refits. Payment of the 2016 final dividend absorbed £21.6m, resulting in net cash at June being £19.9m against £46.0m at the year end. However, the company continues to target a year-end position of £40m as we discuss below.

Central ordering and replenishment system

A highlight of the first half was the completion of the roll-out of the company’s central stock forecasting and replenishment system. This is the biggest operational change the company has ever had, and it is already showing benefits in availability of the right products at the right time of day, while retaining the quality advantages of food freshly prepared on the premises. Additional costs of implementing the system and initial higher wastage had a negative effect on the first half net margin, but efficiency gains should close that difference in the second half with shop staff freed up to focus on serving customers. Additionally, reduced costs following the May closure of the Edinburgh bakery are likely to benefit the second half.

Future expansion potential

Greggs is not short of market opportunities. These exist over a number of areas:

New locations:

Geographical: Greggs is opening its first units in areas of the country it has not previously traded in at all, such as Devon and Northern Ireland.

The company is progressing in moving its location base off the high street. It now stands at 70:30 high street to non-high street, down from 80:20 against a target of 60:40.

As Greggs’ brand shakes off its downmarket image, it is noticing that it is being invited into shopping developments by landlords who would previously have regarded it as unattractive.

With early examples of new formats, such as its first drive-through and a presence at airports, the company is expanding the scope of its market.

New dayparts:

It is clear that Greggs’ initiatives in the breakfast and coffee markets have been a success. Eventually there is no reason why the company should not expand into the evening market, which would represent a major advance in utilising its asset. Not all locations would be suitable, but for example McDonalds already occupies a market in selective locations in the evening market, and similar locations could be suitable for the Greggs brand. The company is already progressing along this road with current menu developments, particularly in hot food. The operating structure can already handle units that trade at non-standard trading hours, for example at airports, or at Victoria Coach Station where it trades to 11pm. There is, however, a bigger job of transition to do in terms of market perceptions, and this should not be seen as a short-term development.

Forecasts

We are leaving our forecasts materially unchanged:

Exhibit 3: No material forecast changes

 

EPS (p)

PBT (£m)

EBITDA (£m)

Old

New

% chg.

Old

New

% chg.

Old

New

% chg.

2017

63.4

63.6

0.3%

80.8

80.8

0.0%

131.4

133.3

1.4%

2018

66.6

66.6

0.0%

83.9

83.9

0.0%

138.3

136.8

-1.1%

Source: Edison Investment Research

Our forecasts assume continuation of H2 like-for-like growth of 3.3%, which is marginally lower than the 3.4% actually achieved in H1. Following a review of refurbishment activity, Greggs has decided to limit refurbishments in the next three years to c 130 sites, to maximise the returns on capex and avoid refitting units that are already trading in the food-on-the-go format. It takes a week out of trading to refurbish a store and, as a result, with 107 stores refurbishments completed in H1, the number of disrupted units in H2 will be heavily reduced, which should help like-for-like sales. In addition the sales benefits of the new stock forecasting and replenishment system should become more apparent in terms of avoiding stock-outs of items that customers want and resulting missed sales.

Gross margins should be under slightly less pressure than in H1 as a result of food purchase cover that gives visibility of full year inflation of 6-7% rather than 7% in H1. The successful implementation of the forecasting and replenishment system should also have margin benefits in H2. Staff in all units had to be trained on operating the new system in H1, and its implementation created some initial stock wastage. While the cost of training is a definite one-off cost, the margin effect of wastage will be progressively reduced as operators learn how to fine-tune the system.

Balance sheet and cash flow

We expect that the company will end the year with £40m of net cash. We forecast second half net profit of £40m, comparable with H216’s £38m, resulting in £56m for the year. That should translate into cash from operating activities of £133.7m, close to last year’s figure. Planned capex of £80m is reduced from the previous target of £85m on the lower number of shop refurbishments, and after total dividend payments of £32m, with other smaller items, we forecast net cash to reduce by £6m on the year.

Valuation: No change

Our valuation of Greggs’ shares is based on a DCF projection, the basis of which was fully explained in our March 2017 note, Successful strategy offers further potential. Since currently our forecasts are unchanged, we make no change to our existing valuation of 1,226p per share.

Exhibit 4: Financial summary

£m

2013

2014

2015

2016

2017e

2018e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

762.4

806.1

835.7

894.2

959.4

1,028.4

Cost of Sales

(305.9)

(304.8)

(305.1)

(324.3)

(346.3)

(368.1)

Gross Profit

456.5

501.3

530.6

569.9

613.1

660.3

EBITDA

 

 

74.9

95.6

113.3

125.9

133.3

136.8

Operating Profit (before amort. and except.)

41.5

58.1

73.1

80.3

81.1

83.9

Intangible Amortisation

0.0

0.0

0.0

0.0

0.0

0.0

Exceptionals

(8.1)

(8.5)

0.0

(5.2)

(9.5)

(6.6)

Other

0.0

0.0

0.0

0.0

0.0

0.0

Operating Profit

33.4

49.6

73.1

75.2

71.6

77.3

Net Interest

(0.2)

0.2

(0.1)

(0.0)

(0.3)

0.0

Profit Before Tax (norm)

 

 

41.3

58.3

73.0

80.3

80.8

83.9

Profit Before Tax (FRS 3)

 

 

33.2

49.7

73.0

75.1

71.3

77.3

Tax

(10.3)

(14.0)

(15.4)

(18.1)

(17.0)

(17.0)

Profit After Tax (norm)

30.9

44.3

57.6

62.3

63.9

66.9

Profit After Tax (FRS 3)

24.2

37.6

57.6

58.0

56.2

61.6

Average Number of Shares Outstanding (m)

100.4

100.5

100.6

100.4

100.4

100.4

EPS - normalised (p)

 

 

30.8

44.0

57.3

62.0

63.6

66.6

EPS - normalised and fully diluted (p)

 

30.5

43.4

55.8

60.8

62.4

65.4

EPS - (IFRS) (p)

 

 

24.1

37.4

57.3

57.7

56.0

61.4

Dividend per share (p)

19.5

22.0

28.6

31.0

32.8

34.8

Gross Margin (%)

59.9

62.2

63.5

63.7

63.9

64.2

EBITDA Margin (%)

9.8

11.9

13.6

14.1

13.9

13.3

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

5.4

7.2

8.7

9.0

8.5

8.2

BALANCE SHEET

Fixed Assets

 

 

268.9

267.4

298.2

323.4

349.1

366.2

Intangible Assets

1.0

4.7

10.2

14.3

14.6

18.1

Tangible Assets

267.8

262.7

284.2

307.4

332.7

346.3

Investments

0.1

0.0

3.8

1.8

1.8

1.8

Current Assets

 

 

65.0

101.5

86.0

92.6

87.7

105.7

Stocks

15.4

15.3

15.4

15.9

17.0

18.1

Debtors

25.0

26.1

27.6

30.7

30.6

32.8

Cash

21.6

43.6

42.9

46.0

40.1

54.9

Other

3.0

16.5

0.0

0.0

0.0

0.0

Current Liabilities

 

 

(80.7)

(102.1)

(106.0)

(121.4)

(119.9)

(125.2)

Creditors

(80.7)

(102.1)

(106.0)

(121.4)

(119.9)

(125.2)

Short term borrowings

0.0

0.0

0.0

0.0

0.0

0.0

Long Term Liabilities

 

 

(17.0)

(20.1)

(11.9)

(29.9)

(29.1)

(28.7)

Long term borrowings

0.0

0.0

0.0

0.0

0.0

0.0

Other long term liabilities

(17.0)

(20.1)

(11.9)

(29.9)

(29.1)

(28.7)

Net Assets

 

 

236.2

246.7

266.3

264.7

287.8

317.9

CASH FLOW

Operating Cash Flow

 

 

82.5

108.6

119.6

133.8

133.7

134.0

Net Interest

(0.0)

0.2

0.2

0.1

0.0

0.0

Tax

(13.2)

(11.5)

(15.9)

(16.2)

(19.5)

(15.7)

Capex

(48.6)

(48.3)

(71.8)

(80.1)

(83.7)

(70.0)

Acquisitions/disposals

0.2

(4.8)

18.1

4.7

2.4

0.0

Financing

0.9

(2.6)

(7.2)

(8.3)

(6.6)

0.0

Dividends

(19.6)

(19.6)

(43.7)

(30.9)

(32.1)

(33.5)

Net Cash Flow

2.2

22.0

(0.7)

3.0

(5.9)

14.8

Opening net debt/(cash)

 

 

(19.4)

(21.6)

(43.6)

(42.9)

(46.0)

(40.1)

HP finance leases initiated

0.0

0.0

0.0

0.0

0.0

0.0

Other

0.0

(0.0)

0.0

0.0

0.0

0.0

Closing net debt/(cash)

 

 

(21.6)

(43.6)

(42.9)

(46.0)

(40.1)

(54.9)

Source: Greggs accounts, Edison Investment Research

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. 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

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Greggs and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
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Frankfurt +49 (0)69 78 8076 960

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Germany

London +44 (0)20 3077 5700

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United Kingdom

New York +1 646 653 7026

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10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. 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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Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Greggs and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
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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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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