Transformation taking shape

Greggs plc 3 August 2018 Update
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Greggs

Transformation taking shape

Interim results

Retail

 

3 August 2018

Price

1,019p

Market cap

£1,031m

Net cash (£m) at H118

43.5

Shares in issue

101.2m

Free float

100%

Code

GRG

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

1.4

(17.2)

(9.1)

Rel (local)

1.2

(17.5)

(11.3)

52-week high/low

1399p

942p

Business description

With nearly 1,900 shops, eight manufacturing and distribution centres and 22,000 employees, Greggs is the UK’s leading ‘food-on-the-go’ retailer. It utilises vertical integration to offer differentiated products at competitive prices.

Next events

Trading update

October 2018

Analysts

Paul Hickman

+44 (0)20 3681 2501

Kate Heseltine

+44 (0)20 3077 5700

Greggs is a research client of Edison Investment Research Limited

Greggs’ interim results, against a backdrop of extreme weather conditions, reinforce progress with the strategic transformation of the brand into a leading ‘food-on-the-go’ format. Innovative new product ranges, a reduced dependence on high street footfall and a major overhaul of the supply chain are creating a solid platform for the next stage of the journey. We forecast strong cash generation and a return to earnings growth in 2019.

Year end

Revenue (£m)

PBT* (£m)

EPS* (p)

DPS (p)

P/E (x)

Yield (%)

12/16

894.2

80.3

62.0

31.0

16.4

3.0

12/17

960.0

81.8

64.5

32.3

15.8

3.2

12/18e

1012.4

81.3

64.0

31.5

15.9

3.1

12/19e

1,084.2

83.4

65.6

32.8

15.5

3.2

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

Encouraging recovery in the second quarter

Greggs’ revamped summer menu and a wider choice of value meal deals appear to have caught the eye of the cost-conscious consumer in the relentless heat. Following on from the heavy snow disruption earlier in the year, the company reported first half like-for-like sales growth of 1.5%, implying a stronger second quarter at around 1.8% compared with 1.3% in the first quarter. Total sales rose by 5.2% to £476m, while underlying operating profit of £25.7m declined by 7% year-on-year, largely attributable to the adverse winter weather. Strong operating cash flows resulted in a net cash position of £43.5m (H117: £19.9m).

Decoupling from high street trade

The company has adjusted its guidance for store openings, down from 110-130 to about 100 net new stores this year. The emphasis for new outlets remains focused on locations that capture work, travel and leisure-related footfall, thus reducing the chain’s high street exposure. 35% of stores now service non-retail trade and the company expects that proportion to rise to approximately 50% over the longer term.

The digital opportunity

As the brand transformation continues to gather momentum, a next logical step would be to develop the digital platform, both in store and for customers to place advance orders for delivery or collection. The fact that Greggs prepares much of its food freshly on site each day and has the ability to tailor orders to meet individual customer requirements is a clear differentiator. Plans are underway to trial the first ‘click-and-collect’ store towards the end of the year.

Valuation: No change

Despite an improved sales performance in the second quarter, we are mindful of the general weakness in consumer sentiment and ongoing inflationary cost pressures. As such, we are not materially changing our 2018 forecast for broadly flat underlying profit growth year-on-year, consistent with company guidance. We retain our valuation of 1,360p per share.

Interims: Resilience despite challenging conditions

In a period that has largely been governed by long spells of extreme weather - ‘the Beast from the East’ in April/May, followed by an on-going heatwave - Greggs’ resilient sales performance reinforces the progress it is making with the brand’s strategic transformation.

Exhibit 1: Group sales and profit

£m

H118

H117

Change

Sales

476.3

452.9

5.2%

Operating profit (before property and exceptional items)

25.7

27.6

-6.9%

Property disposal gains

(0.1)

0.3

EBIT (before exceptional items)

25.9

27.9

-7.2%

Net exceptional charge

(1.9)

(8.3)

Finance income

0.0

(0.1)

Profit before taxation

24.1

19.4

+24.2%

Source: Greggs

Total sales in the first half rose by 5.2% year-on-year to £476m and like-for-like sales increased by 1.5%, with stronger transaction numbers and average transaction values driving an encouraging recovery in like-for-like sales in the second quarter, despite the unusually hot weather. Second quarter like-for-like sales increased by 1.8% compared with 1.3% in the first quarter.

This has been, in part, attributable to the diversification of ranges away from traditional bakery products. Customers now have a wider choice of hot and cold food and beverages, and the value meal deals have been expanded. The ‘growth categories’, which encompass hot drinks, breakfasts, healthier choices and hot food, now represent 30% of the sales mix compared with just 15% five years ago. Greggs is now number four for coffee in the UK.

Further, the repositioning of the store portfolio to capture work, travel and leisure-related trade is increasingly insulating the company against challenging high street conditions. Key openings in the period include the chain’s first Underground store at Westminster tube station, in addition to stores at Birmingham New Street station and Glasgow Buchanan bus terminal. 35% of stores now service non-retail trade and that proportion is expected to reach approximately 50% over the longer term.

Underlying operating profit, excluding property profits and exceptional items, declined by 7% compared with the prior period, to £25.7m. This reduction was largely attributable to the disruption to trading caused by the Beast from the East, and was flagged in the company’s May trading update. Stripping out this anomaly, management has indicated that profits would have moved slightly ahead year-on-year.

Exhibit 2: Margin analysis

H118

H117

Sales (£m)

476.3

452.9

Gross margin

63.0%

63.3%

Distribution & selling costs as a percentage of sales

-52.3%

-51.5%

Admin expenses as a percentage of sales

-5.3%

-5.7%

Operating margin (before property and exceptional items)

5.4%

6.1%

Property disposal gains as a percentage of sales

0.1%

0.1%

EBIT margin (before exceptional items)

5.4%

6.2%

Source: Greggs

Input cost pressures remained broadly consistent with management’s expectations during the period. Ingredient price inflation is now running at 3-4% compared with 6-7% in 2017, albeit with the hot weather increasing pressure on grain and milk yields. Wage and salary inflation has increased by 40bp year-on-year and is now running at 3.6%. The main change in recent months has been the double-digit acceleration in energy costs, although these only represent approximately 4% of the total cost base compared with ingredients and people costs, which account for approximately 65% of total costs when combined.

The resulting impact has been a 30bp reduction in the gross margin. The 80bp increase in distribution and selling costs as a percentage of sales not only reflects cost pressures but, more significantly, the negative impact of operational gearing in the business when set against lower like-for-like sales. In contrast, admin costs as a percentage of sales improved by 40bp due to tight cost control and lower incentive costs. Overall, these combined factors resulted in an 80bp reduction in the operating margin to 5.4%.

Exceptional charges peaked and now declining

As previously flagged, the £100m investment programme to reshape manufacturing and logistics operations is expected to generate £30m of exceptional one-off charges over the five-year period to 2020. Including the first half net exceptional charge of £1.9m, total charges to date have amounted to £18.8m. Over the balance of the programme a further £11m of exceptional items are expected to be charged to the P&L.

Exhibit 3: Exceptional phasing 2016-20e

£m

FY16 & FY17

H118

H218e

2019e

2020e

Total

Cash change costs

13.7

1.4

3.7

3.2

3.0

25.0

Non-cash (asset-related) charges

3.2

0.5

0.5

0.8

-

5.0

Exceptional P&L charge

16.9

1.9

4.2

4.0

3.0

30.0

Expected cash cost phasing

5.7

2.6

8.7

5.0

3.0

25.0

£19m charged to date

£11m expected through to 2020

Source: Greggs

Major projects include the consolidation of manufacturing lines across multiple sites into single ‘centres of excellence’, a recent example being the installation of a doughnut-manufacturing platform in Newcastle to supply the entire stores network. To date three of Greggs’ 11 traditional bakeries have been closed, with one further closure of a facility in Norwich scheduled for the end of the year. The seven remaining sites will combine manufacturing operations with an increased capacity for distribution. Planning is underway for the opening of a new distribution centre in Wiltshire in 2019, which will service stores in the south.

On completion of the programme, the supply chain is expected to provide capacity to grow the estate to approximately 2,500 stores that, at the current rate of 100 planned openings per annum, would be achieved by 2024. Although Greggs has not committed to an optimal number of outlets, this scale is comparable with ‘out-of-home’ peers such as Costa’s UK store portfolio.

Strong cash generation and net cash position

The company has continued to generate robust cash flows. In the first half the net cash inflow from operating activities was £39.0m (H117: £34.0m), leading to a net cash balance of £43.5m at the end of the period (H117: £19.9m). This is consistent with the company’s target net cash position of approximately £40m. Given the on-going higher levels of investment, it does not expect to return capital to shareholders ahead of the completion of the transformation programme in 2020.

The digital opportunity

Greggs has already made significant progress in its transformation from a traditional high street bakery chain to a well-diversified value ‘food-on-the-go’ format.

Looking ahead, a next logical step would be to develop the digital platform, both in store and for customers to place online orders in advance, via the internet or an app, for delivery or collection.

Within the sector McDonald’s has pioneered touch screen order and payment technology in store. This not only mitigates bottlenecks of customers waiting to place orders and collect food at the tills, but has also increased the average basket size, as the technology is able to suggest special offers and meal accompaniments as the customer moves through the ordering process.

The ‘click-and-collect’ opportunity is also significant and Greggs expects to trial its first store towards the end of the year. The fact that Greggs makes its sandwiches and a number of other products freshly on site each day is a clear differentiator. Customers ordering remotely would not only be able to ensure their food choice is in stock, but also tailor it to some extent to their personal requirements. The greatest obstacle is likely to be in ensuring stock availability and management anticipates that trials may last up to two years before the concept can be rolled out more widely.

Forecasts

Our forecasts remain materially unchanged.

Exhibit 4: Changes to forecasts

Normalised EPS (p)

Normalised PBT (£m)

EBITDA (£m)

Old

New

% chg.

% growth y-o-y

Old

New

% chg.

% growth y-o-y

Old

New

% chg.

% growth y-o-y

2018e

63.7

64.0

0.5

(0.7)

81.9

81.3

(0.7)

(0.7)

138.3

136.7

(1.2)

0.7

2019e

65.9

65.6

(0.5)

2.5

83.8

83.4

(0.5)

2.2

146.1

145.6

(0.3)

6.6

2020e

72.1

72.4

0.4

10.4

90.8

91.2

0.4

10.4

156.7

157.4

0.4

8.1

Source: Edison Investment Research

Based on the stronger performance in second quarter we have raised our like-for-like sales growth assumption from 0.5% to 1.3% for the second half of the year, against a challenging prior year comparative. Across the full year we expect like-for-like sales growth of 1.4%. In line with revised company guidance, we have reduced our forecast net openings from 110 to 100 stores in 2018e, weighted towards the back end of the year.

Based on the inflationary cost pressures outlined on pages 2-3, we now assume a 40bp reduction in the 2018 gross margin. We would expect this to be recovered over the following two years as benefits from the supply chain investment programme start to take effect.

Consistent with the trend seen in the first half, we expect to see sustained pressure on distribution and selling costs as a percentage of sales across the full year, partially offset by tighter cost controls. We forecast a profit before tax, before property gains and exceptional items, of £81.3m (previously £81.9m) for 2018. In subsequent years, we forecast a return to earnings growth and a profit before tax, before property gains and exceptional items, of £83.4m and £91.2m in 2019 and 2020, respectively.

Capital expenditure and net cash

We have adjusted our capex assumptions over the three years to 2020e to reflect revised guidance on the timings of expenditure. In 2018e we have reduced capex from £95m to £90m, with a further £95m and £85m of expenditure in 2019e and 2020e respectively. Total expenditure of £270m over the three-year period remains unchanged. We are forecasting a 2018 year-end net cash position of £41.1m (previously £35.7m).

Valuation

Our forecasts have not materially changed and we therefore retain our existing valuation of 1,360p per share. Our valuation is based on a blended average of both DCF and peer group analysis, as detailed in our note, Growth moderates, but strategy on plan, published on 10 May 2018.

Factoring in a post-results rally, Greggs’ share price has declined by approximately 25% year to date. The company trades on a 15.5x 2019e P/E and 7.3x EV/EBITDA multiple. The latter represents a 35% discount to the peer group, which we do not believe to be sustainable for any length of time.

Exhibit 5: Financial summary

£m

2016

2017

2018e

2019e

2020e

Dec

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

 

Revenue

 

 

894.2

960.0

1,012.4

1,084.2

1,154.0

Cost of Sales

(324.3)

(348.1)

(371.3)

(395.1)

(418.2)

Gross Profit

569.9

611.9

641.1

689.1

735.8

EBITDA

 

 

125.9

135.7

136.7

145.6

157.4

Operating Profit (before amort. and except.)

80.3

82.2

81.4

83.2

91.0

Intangible Amortisation

0.0

0.0

0.0

0.0

0.0

Exceptionals

(5.2)

(9.9)

(6.0)

(4.0)

(3.0)

Other

0.0

0.0

0.0

0.0

0.0

Operating Profit

75.2

72.3

75.4

79.2

88.0

Net Interest

(0.0)

(0.4)

(0.1)

0.2

0.2

Profit Before Tax (norm)

 

 

80.3

81.8

81.3

83.4

91.2

Profit Before Tax (FRS 3)

 

 

75.1

71.9

75.3

79.4

88.2

Tax

(18.1)

(16.9)

(16.8)

(17.5)

(18.5)

Profit After Tax (norm)

62.3

64.9

64.4

65.9

72.7

Profit After Tax (FRS 3)

58.0

56.9

59.6

62.7

70.3

Average Number of Shares Outstanding (m)

100.4

100.6

100.7

100.4

100.4

EPS - normalised (p)

 

 

62.0

64.5

64.0

65.6

72.4

EPS - (IFRS) (p)

 

 

57.7

56.5

59.2

62.4

70.0

Dividend per share (p)

31.0

32.3

31.5

32.8

36.2

Gross Margin (%)

63.7

63.7

63.3

63.6

63.8

EBITDA Margin (%)

14.1

14.1

13.5

13.4

13.6

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

9.0

8.6

8.0

7.7

7.9

 

BALANCE SHEET

 

Fixed Assets

 

 

323.4

334.7

376.0

408.5

427.1

Intangible Assets

14.3

14.7

18.3

20.7

20.7

Tangible Assets

307.4

319.2

354.2

384.3

402.8

Investments

1.8

0.8

3.6

3.6

3.6

Current Assets

 

 

92.6

106.6

95.7

101.3

119.1

Stocks

15.9

18.7

19.5

20.8

23.2

Debtors

30.7

33.4

35.1

37.4

39.8

Cash

46.0

54.5

41.1

43.1

56.2

Other

0.0

0.0

0.0

0.0

0.0

Current Liabilities

 

 

(121.4)

(127.9)

(134.8)

(141.6)

(138.2)

Creditors

(121.4)

(127.9)

(134.8)

(141.6)

(138.2)

Short term borrowings

0.0

0.0

0.0

0.0

0.0

Long Term Liabilities

 

 

(29.9)

(14.0)

(8.1)

(7.0)

(6.6)

Long term borrowings

0.0

0.0

0.0

0.0

0.0

Other long term liabilities

(29.9)

(14.0)

(8.1)

(7.0)

(6.6)

Net Assets

 

 

264.7

299.4

328.8

361.1

401.5

 

CASH FLOW

 

Operating Cash Flow

 

 

133.8

134.5

133.2

145.8

147.7

Net Interest

0.1

0.2

(0.1)

0.2

0.2

Tax

(16.2)

(17.6)

(18.2)

(16.7)

(17.9)

Capex

(80.1)

(72.6)

(90.0)

(95.0)

(85.0)

Acquisitions/disposals

4.7

2.2

(4.1)

(1.0)

0.0

Financing

(8.3)

(6.0)

(1.2)

(0.0)

(0.0)

Dividends

(30.9)

(32.2)

(33.1)

(31.4)

(32.0)

Net Cash Flow

3.0

8.5

(13.4)

1.9

13.1

Opening net debt/(cash)

 

 

(42.9)

(46.0)

(54.5)

(41.1)

(43.1)

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)

 

 

(46.0)

(54.5)

(41.1)

(43.1)

(56.2)

Source: Greggs, 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 Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER Copyright 2018 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 Investment Research Pty Ltd (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. 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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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 Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER Copyright 2018 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 Investment Research Pty Ltd (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. 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. 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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 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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