On target

Greggs 11 May 2016 Update

Greggs

On target

Trading update

Retail

11 May 2016

Price

1,089.00p

Market cap

£1,102m

Net cash (£m) at December 2015

42.9

Shares in issue

101.2m

Free float

100%

Code

GRG

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

0.5

10.8

(6.0)

Rel (local)

1.2

2.2

6.1

52-week high/low

1,355.00p

969.00p

Business description

With 1,720 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

Interim results

2 August 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 reports that, after 18 weeks’ trading, it remains on target to meet full-year expectations. The range of business initiatives is on track and we are leaving our PBT estimates unchanged. Our valuation of 1,169p a share represents a slight increase from our previous valuation of 1,158p.

Year end

Revenue
(£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/14

806.1

58.3

44.0

22.0

24.8

2.0

12/15

835.7

73.0

57.3

28.6

19.0

2.6

12/16e

881.8

77.1

60.4

29.9

18.0

2.7

12/17e

941.5

84.8

66.5

33.0

16.4

3.0

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

Solid start to the year

Greggs has reported l-f-l sales growth in company-owned shops of 3.7% in the first 18 weeks of the year. Total sales growth for the period was 5.7%. While these growth rates are slower than those recorded in the first eight weeks of the year, they remain ahead of our modelled full-year sales growth and leave management expecting “to make progress in line with our previous expectations”.

Estimates unchanged

Sales growth continues to run ahead of the pace that we have assumed in modelling FY16. Greggs advises that input cost inflation remains low, providing an offset to the pressure that the National Living Wage is applying to the entire retail industry. Formal consultations on the closure of three bakeries as part of the supply chain transformation programme have completed and that important project remains on track. Overall, Greggs remains slightly ahead of our FY16 assumptions, but not by enough to justify a change in estimates at this early stage.

Valuation: Slight increase

By reference to the average CY16 multiple for the FTSE 250 of c 10x, we propose a valuation of 1,169p a share, a modest increase from our previous valuation of 1,158p. Our initial valuation of Greggs was based on a DCF methodology, which we believe makes the valuation very sensitive to small changes in gilt yields. These may be artificially low at the moment and in future could also experience volatility from extraneous factors such as Brexit.

Q1 trading update

Greggs’ trading update for the 18 weeks to 7 May was highly encouraging: l-f-l sales growth, store refits and net new store openings are all either in line with, or ahead of the run rates assumed in our FY16 estimate.

Total sales for the 18 weeks grew by 5.7% and l-f-l sales in company-managed shops grew by 3.7% over the same period. This marked a slowdown from the 6.8% ‘total’ and 4.2% ‘l-f-l’ Greggs reported for the first eight weeks of the period. The bulk of the slowdown occurred in March, during which footfall was weak across the retail industry: the British Retail Consortium reported a 3.9% year-on-year high street footfall decline in March in an overall retail industry footfall decline of 2.7%. During April l-f-l sales accelerated again to the ‘high 3%s’.

Part of the l-f-l sales gain originates from the store refit programme. Greggs aims to refit 200 stores this year. It completed 55 refits in the first 18 weeks. As new stores mature over their early years, they too add to l-f-l sales growth. Last year’s openings benefited the most recent l-f-l picture and this year’s new units will benefit next year’s. Greggs opened 43 stores in the first 18 weeks, including 23 franchised units with existing franchise partners, and closed 21 giving a net gain of 22. The net addition is encouraging given Greggs’ sensible tendency to focus closures in Q1 after reaping the benefit of Christmas trading. The estate totalled 1,720 stores at 7 May, including 128 franchised units. That included the chain’s first company-owned shop in Northern Ireland, which opened in March.

Both food ingredient and packaging cost inflation remain low, which is allowing Greggs to offset the impact of a 5% wage award to shop staff that became effective in April.

Supply chain investment plans on track

In our initiation note we highlighted Greggs’ plans to invest £100m over five years to upgrade its supply chain. Those plans aim to create additional national manufacturing centres of excellence and increase capacity to serve more than 2,000 outlets. The formal collective consultation on the proposals to close three bakeries as part of the programme has now ended. The smallest site at Sleaford has already closed. Greggs expects to close its Twickenham bakery in Q416 followed by Edinburgh in Q217. The activities of those two sites will transfer to Enfield and Glasgow respectively.

Improvement through change programme on track

The ‘improvement through change’ programme is a five-year, £25m investment in systems targeting annual net benefits of £6m per year. Greggs has delivered, on schedule, the planned migration of its finance systems onto the SAP platform during the first 18 weeks of FY16. The initial signs are that this change was successful. That will allow Greggs to move onto the next phase, shop ordering, which it will trial during the autumn and, if the trials go well, roll out in FY17.

Estimates unchanged

Given management’s statement that it expects “to make progress in line with our previous expectations”, we are leaving our PBT estimates unchanged. The variance in performance versus our assumptions is not so great as to warrant a change at this early point in the year. We model FY16 sales growth of 5.5%, incorporating like-for-like growth of 2.7% and a 2.8pp contribution from the return to opening net new stores. Our assumed like-for-like sales growth is below the +3.7% achieved in the first 18 weeks of FY16, which creates a margin of safety. Given guidance that input cost inflation remains low, we continue to expect an increase in H1 gross margin to lead to a gain of 10bp in the full-year gross margin. Greggs has implemented its 5% pay increase for shop staff and 4% increase for store managers, which will add an incremental £3m to distribution and selling costs. The continuing investment in the various elements of the strategic plan will see depreciation and amortisation continue to increase. Nevertheless, the gross margin gain and operating leverage should allow the operating margin to hold at 8.7%. Underlying EBIT increases from £73.1m to £77.0m. This is before £7m of exceptional charges relating to the closure of facilities as part of the supply chain investment programme, most or all of which we expect to fall in FY16. Greggs has guided that the FY16 tax rate will be c 22%, with the rate in subsequent years being c 2pp above the headline rate.

Sensitivities

The data continue to suggest that consumer spending should increase this year. Moreover, Greggs is already ahead of our full year target for sales growth and should therefore be able to weather the odd weak month such as March and still hit targets. The margin picture also appears encouraging. Greggs has visibility on packaging costs for the remainder of FY16 and on food ingredients as far as August. The pay increase has already gone through so the major income and expense lines appear to be secure. Barring an unexpected collapse in consumer spending, estimates should be attainable.

Valuation slightly increased

The FTSE 250 is trading at a CY16 EV/EBITDA multiple of c 10x, which indicates a value for Greggs of 1,169p. That is close to our DCF-derived initiation valuation of 1,158p (see initiation note). The resulting dividend yields would be 2.6% and 2.8%, which are lower than the corresponding FTSE 250 numbers of 2.9% and 3.1%. However, Greggs has a history of returning additional cash to shareholders over and above the ordinary dividend. Our modelling suggests that there will be scope for further such returns in due course.

Our initiation valuation was based on a 6.9% equity cost of capital. However, we are not inclined to over-rely on the DCF approach as it is unclear whether the recent reductions in 10-year gilt yields are sustainable or relevant, and we believe that changes driven by extraneous factors (such as Brexit) could result in inappropriate volatility in such valuations.


Exhibit 1: Financial summary

£m

2013

2014

2015

2016e

2017e

Dec

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

762.4

806.1

835.7

881.8

941.5

Cost of Sales

(305.9)

(304.8)

(305.1)

(320.8)

(342.5)

Gross Profit

456.5

501.3

530.6

561.0

599.0

EBITDA

 

 

74.9

95.6

113.3

122.0

132.3

Operating Profit (before amort. and except.)

41.5

58.1

73.1

77.0

84.7

Intangible Amortisation

0.0

0.0

0.0

0.0

0.0

Exceptionals

(8.1)

(8.5)

0.0

(7.0)

0.0

Other

0.0

0.0

0.0

0.0

0.0

Operating Profit

33.4

49.6

73.1

70.0

84.7

Net Interest

(0.2)

0.2

(0.1)

0.1

0.1

Profit Before Tax (norm)

 

 

41.3

58.3

73.0

77.1

84.8

Profit Before Tax (FRS 3)

 

 

33.2

49.7

73.0

70.1

84.8

Tax

(10.3)

(14.0)

(15.4)

(16.3)

(17.9)

Profit After Tax (norm)

30.9

44.3

57.6

60.8

66.9

Profit After Tax (FRS 3)

24.2

37.6

57.6

55.3

66.9

Average Number of Shares Outstanding (m)

100.4

100.5

100.6

100.6

100.7

EPS - normalised (p)

 

 

30.8

44.0

57.3

60.4

66.5

EPS - normalised and fully diluted (p)

 

30.5

43.4

55.8

58.9

64.8

EPS - (IFRS) (p)

 

 

24.1

37.4

57.3

54.9

66.5

Dividend per share (p)

19.5

22.0

28.6

29.9

33.0

Gross Margin (%)

59.9

62.2

63.5

63.6

63.6

EBITDA Margin (%)

9.8

11.9

13.6

13.8

14.1

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

5.4

7.2

8.7

8.7

9.0

BALANCE SHEET

Fixed Assets

 

 

268.9

267.4

298.2

323.2

350.6

Intangible Assets

1.0

4.7

10.2

15.3

20.0

Tangible Assets

267.8

262.7

284.2

304.0

326.7

Investments

0.1

0.0

3.8

3.8

3.8

Current Assets

 

 

65.0

101.5

86.0

86.8

104.6

Stocks

15.4

15.3

15.4

15.7

16.8

Debtors

25.0

26.1

27.6

27.7

29.6

Cash

21.6

43.6

42.9

43.4

58.2

Other

3.0

16.5

0.0

0.0

0.0

Current Liabilities

 

 

(80.7)

(102.1)

(106.0)

(103.4)

(108.9)

Creditors

(80.7)

(102.1)

(106.0)

(103.4)

(108.9)

Short term borrowings

0.0

0.0

0.0

0.0

0.0

Long Term Liabilities

 

 

(17.0)

(20.1)

(11.9)

(10.9)

(10.4)

Long term borrowings

0.0

0.0

0.0

0.0

0.0

Other long term liabilities

(17.0)

(20.1)

(11.9)

(10.9)

(10.4)

Net Assets

 

 

236.2

246.7

266.3

295.7

335.9

CASH FLOW

Operating Cash Flow

 

 

82.5

108.6

119.6

115.0

138.3

Net Interest

(0.0)

0.2

0.2

0.1

0.1

Tax

(13.2)

(11.5)

(15.9)

(14.8)

(17.9)

Capex

(48.6)

(48.3)

(71.8)

(85.0)

(75.0)

Acquisitions/disposals

0.2

(4.8)

18.1

15.0

0.0

Financing

0.9

(2.6)

(7.2)

0.0

0.0

Dividends

(19.6)

(19.6)

(43.7)

(29.8)

(30.7)

Net Cash Flow

2.2

22.0

(0.7)

0.5

14.8

Opening net debt/(cash)

 

 

(19.4)

(21.6)

(43.6)

(42.9)

(43.4)

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)

(43.4)

(58.2)

Source: Greggs, Edison Investment Research. Note: Normalised profit is before exceptional items, but includes share-based payments.

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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

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Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

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