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September Idea Competition - GREGGS plc (LSE: GRG)
INTRODUCTION

Our selection is Greggs (Market Cap of £2.01B), a bakery chain known for sausage rolls which transformed into a modern vertically integrated UK food-on-the-go retailer, providing a wide menu of food and drink choices. Greggs is being around for over 80 years in UK and serves consumers through 2,239 stores (401 are franchised). In the first half of 2022, Greggs generated £694.5M sales and £55.8M Pre-tax profit.

During the last 10 years it depicted a Revenue and Operating income CAGR of 6.9% and 12.3%, respectively, with an average operating margin of 8.0% and average Return on Equity of 19.5%, whereas its share price grew by 425%.

Greggs has a cash position of £147.5M, undrawn facilities of £70M and lease liabilities of £290.9M.

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Koyfin, StockOpine

THESIS

  1. Growing number of stores boosting revenues

  • Greggs plans to increase its number of stores from 2,239 to +3,000 by 2026, adding (net) 150 stores per annum, doubling its revenue from £1.23B in 2021 to £2.4B in 2026.

  • Although the target set (Capital Market Day 10/2021) is ambitious, it is not necessarily unachievable given that Greggs added on average (net) 97 stores for 2017-2021 (excluding 2020). The target was recently reaffirmed by management.

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Capital Markets Day, 2021

  1. Increase in Revenue per Store

  • Over 2012 – 1H 2022 (“Current/LTM”), Greggs grew revenue per store by a CAGR of 3.4%. An acceleration is expected as Greggs extends opening hours, adds delivery to more stores and as it enhances its CRM platform.

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Greggs filings, StockOpine

  • Evening Trade: Management expects to extend opening hours of stores, where meaningful, to at least 6pm (normal closing hour used to be 4pm). Currently, 300 stores are open until 8pm and the plan is to reach 500 stores by year-end.

There is a significant upside from extending trade (35% of food-on-the-go market) since it would allow offering of wider range of products at higher prices (e.g. Sausage roll £1.2 Vs Southern Fried Goujons £2.75).

  • Delivery: Beginning of 2021: 600 -> today: 1,180 and plan for 1,300 by the year-end. Delivery can be margin dilutive, but sales accretive (small switching level) as it reaches more customers and has higher basket size.

  1. Attractive Valuation

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StockOpine

The estimated value per share is £25, 27.0% higher than our entry price of £19.7 on 16th of September (screenshot below), with a resulting IRR over a 5-year period of 16%.

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  • Revenue is based on management target, which per our recalculations translates into a) accelerating Revenue growth per Store (+7% CAGR) driven by Delivery, Evening Trade and Loyalty/CRM and b) the increasing number of stores.
  • Terminal margin of 17.5%, lower than the average of 18.8% (2016-2021, excluding 2020) due to investment requirements as stores are added and due to a higher weight of delivery sales compared to the current 7% of total sales.
  • Discount rate represents the minimum required return that we aim from our investments (i.e., 10%) and it is higher than the estimated WACC of 9.6%.
  • EV/EBITDA multiple of 9x is similar to its 5Y average (9.1x), excluding 2020, and slightly higher than its current multiple of 8.4x. Despite this, it is lower than the median 13.9x of UK selected peers.

Potential upside / downside (%) by changing EBITDA multiple and Discount rate

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StockOpine

RISKS

  1. Execution risk

  • Roisin Currie, CEO recently succeeded Roger Whiteside and as there is no record to assess her abilities there is an execution risk. Nevertheless, Roisin is with the company since 2010, knows the culture and values and was selected across internal and external candidates.

  1. Fragmented market

  • There is competition from Cafes like Costa Coffee and Starbucks, bakeries such as Wenzel’s the Bakers and companies like Krispy Kream UK and Subway. Despite the competition; the long track record, the competitive pricing position and the increasing number of stores demonstrate Greggs’ strong competitive positioning in a fragmented market.

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Statista, Bakery Market Report (WilliamReed), StockOpine

  1. Inflation

  • Even though Greggs is vertically integrated, it is not immune to inflationary pressures (ingredients, energy) and thus some costs will be absorbed, where others, would be passed to consumers (price hikes already took place in 2022).

  • Unexpected increase in CAPEX may delay store openings. For instance, estimated CAPEX per shop increased from c. £275,000 (Oct 2021) to c. £325,000 per interim results.

REMARKS

We initiated a position in Greggs, as the 27% upside provides sufficient margin of safety considering the risks identified above.

Disclaimer: Not a financial advice.
StockOpine's avatar
We would also like to thank @investmenttalk for bringing Greggs to our attention in a post we shared recently @commonstock . 👇

Various companies were shared on this post (thank you fellow investors!) for investment ideas but Greggs was the winning idea for our portfolio.

SLT Research's avatar
Always good to read a write-up from you guys! Valuation looks attractive and thanks for the scenario analysis.
I understand historical revenue growth was driven by adding new locations but going forward the key seems to be Greggs' ability to increase its revenue/store because 150 new stores p.a. until 2026 at a revenue/store of £623.5k gives us c.£467m of incremental revenue, short from the £600m target (which implies a £800k revenue/store).
StockOpine's avatar
Thank you @slt_research . It is indeed attractive. Under a different environment, one could use a different/lower discount rate but given the circumstances, 10% is reasonable and it still gives a 27% upside.

The £800k revenue/store is correct but in that number you need to account a normal 3.4% annual growth per store (goes to c. £683k revenue/store by 2026, basis 2021) plus the additional upside per store due to evening trade and delivery.

Let us know if this is clear.
SLT Research's avatar
@stockopine totally clear. Thanks
StockOpine's avatar
@slt_research perfect 👌🏼
Todor Kostov's avatar
Thanks for the detailed analysis.

The questions I have on my mind are:

  1. Why should we expect +3000 stores in 2026 (a growth of 34% in total units) while for the past 9 years they were able to grew the store count roughly with 30% altogether?
  1. Are we factoring the possibility of over-saturating the already heavily fragmented market for fast casual food in the UK (KFC recently announced plans for 500 new locations accross the country, currently they have more than 900 locations)?
  1. How confident are we that the planned evening trade business (meaning upscaling the brand and re-positioning it) will deliver bottom-line profit growth (operational and marketing costs will significantly increase).
StockOpine's avatar
Thank you @kostofff for the questions. We will try to answer those in the same order.
  1. This is a management target and they seem to be executing. They already opened 58 in the first half of 2022 and reaffirmed that they are on track to achieve 150 p.a. Based on past growth one can argue that this target is ambitious and we tend to agree. Despite this, a lot has happened since 2013. The Company from a bakery chain it transformed into a vertically integrated business and considering these changes we believe that it was reasonable to have a slower pace of growth in the number of stores which nonetheless was impressive.

  1. It is one of the concerns that we have as well since the market is highly fragmented. Despite this, management shared a slide in its Capital Market day demonstrating that they could achieve 4,000 stores (aggressive target) and thus they considered +3,000 a reasonable target based on population density. What we noted since 2015 is that Greggs was one of the few companies that managed to grew its number of stores (including 2020) which effectively demonstrates the competitive positioning of Greggs. Nevertheless, it remains one of the key risks.

  1. They have already repositioned themselves into a food-on-the-go brand. What they need to do on that aspect is to enhance/tailor menu so as to be able to grab more than the 1% share of the FTG dinner market. From a survey, Management indicated that 30% of customers surveyed believe that the existing menu has options suited to the evening. Based on that, we do not think that this business is margin dilutive but the opposite given the economies of scale that Greggs has and the higher prices of evening options vs breakfast options.

Hope that the above answer your questions.
Todor Kostov's avatar
@stockopine Thanks for the clarifications. It's going to be a challenge for them but hope they execute and results follow.
StockOpine's avatar
You are welcome @kostofff . Indeed. It is an ambitious target and the key metrics should be closely monitored. On a positive note, Evening or Delivery could surprise us.
Conor Mac's avatar
@kostofff Just wanted to say, these were some fantastic questions @kostofff and great responses @stockopine!
StockOpine's avatar
Thank you @investmenttalk ! Appreciate the feedback.
Kleanthis Kle's avatar
Very ambitious goals set by the management given the inflationary pressure which are expected to worsen in the near future! Nevertheless, the key fact in my opinion is that they are not just expanding their existing bussiness but they are trying to make a major entrance in a different market (e.g. evening food on the go market and delivery), idea-wise they seem very promising as the transition should't be a difficult task (they have the know-how, they need to make some small amendments), ofcourse the decisive factor will be the reaction of the public!
Therefore, thank you @stockopine for sharing this post and choosing a promising company that is not just moving ahead with a conventional expansion but it is envisaging to enhance its business by entering a different market.
Has the management carried out a feasibility study especially as to the reaction of the market?
StockOpine's avatar
Thank you @klean for your comments. We totally agree that inflation is going to play a role in achieving the goals set by management, however, even in July 2022 they reaffirmed the goal of 150 stores p.a. As inflation is spiking, it could be a short term headwind for Greggs but not necessarily a strategy shift.

In regards to the feasibility, Greggs mentioned in their 2021 report that from a survey carried out, 30% of customers surveyed believe that the existing menu has options suited to the evening. Additionally, from initial trials on 100 shops, in 2021 (offering the existing menu), it was shown that they can grow evening trade to 17% of daily sales.
Kleanthis Kle's avatar
@stockopine Thank you for your reply. I like your holistic approach to the matter, not only have you reviewed the numbers but the management rationale analysis is very crucial and you have provided us with very valuable information. I will be definetely keeping an eye on Greggs.
I would also like to ask, has the management commented on their financing plans for the expansion? Whether new equity will be issued, existing free cash flow, perhaps a combination of the above and a loan?
StockOpine's avatar
Thank you @klean . In relation to funding, managements expects to self-fund the expansion while maintaining a net cash position.
The peak in CAPEX is expected in 2023 and 2024 (£200M-£220M p.a.) which are sufficiently covered by operating cashflows (e.g. £219M in 2019 and £285.5M in 2021).

Nonetheless, the company has cash position of £147.5M and undrawn facilities of £70M.

Hope that the above makes sense.
Kleanthis Kle's avatar
@stockopine Thank you. If I am not mistaken you made a small transposition typing error, the cash position is currently £145.7M.

Indeed the numbers are auspicious for the future, there is a constant growth (with the exception of the covid period that almost affected every sector, so I would ignore that), I hope it works out well for you!
StockOpine's avatar
well spotted @klean :) Thank you.
Antonis Hadjiforados's avatar
Good idea taking inflation as one of the major risks! It seems to be the most significant risk nowadays to all of the stocks!
StockOpine's avatar
@ahadjiforados indeed. Greggs reputation as 'value for money' could prove to be defensive under the current market conditions.
Always good to read from you guys. Great work again. Thank you for the analysis!
StockOpine's avatar
Thank you @plouta 👏👏
Edmund Simms's avatar
I love Greggs, although I haven't valued them since March.

While the company's top line has increased, revenues per shop tell a different story. On a per-shop basis, revenue growth has not beaten inflation since 2004. In real terms, each shop turns over the same amount as 17 years ago.

Thanks for sharing this write up
StockOpine's avatar
Thank you for the comments @valuabl . You are right. Effectively the real growth was driven by number of stores and not revenue per store (in real terms). However, this makes sense given Greggs position in the market (competitive pricing positioning). Despite this, Evening Trade and Delivery could be the catalysts for a growing revenue per store (in real terms).

It shall also be noted that Greggs accounts for c.9-11% of breakfast FTG market but only 1% of the evening/dinner FTG.

On another note, we would love to see a revised valuation from you.
Great analysis @stockopine . Keep up the good work!
StockOpine's avatar
Thank you @sofoklis18 !
amazing report guys!!
StockOpine's avatar
Thank you @michail !
Great report team!
Buy those sausage rolls…growth is inevitable😎😎
StockOpine's avatar
@sko indeed. :) Growth is expected from both an increase in the number of stores and revenue per store (evening trade, delivery).
Conor's avatar
Great analysis and very clear, easy-to-understand writing.

Multiple is trading near 5-year average but below UK peers. Pretty good risk-adjusted bet considering the upside.

EV/EBITDA multiple of 9x is similar to its 5Y average (9.1x), excluding 2020, and slightly higher than its current multiple of 8.4x. Despite this, it is lower than the median 13.9x of UK-selected peers.


I really want a sausage roll now. I hope they come to the US one day...I could always come to the UK too
StockOpine's avatar
Thank you @conorvalue . Our educated guess is that you need to visit UK :) it is unlikely for Greggs to consider international expansion anytime soon (we could be wrong but the focus is on local expansion, evening trade and delivery).
Conor's avatar
@stockopine we don't even have sausage rolls here so they would be competing against no one.

StockOpine's avatar
@conorvalue interesting. It seems like a blockbuster move for Greggs 💭

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