Greggs offers post-pandemic value and growth

It’s been a horrible year for the UK’s favourite dining brand, Greggs. Lockdown has meant temporary shop closures and a sharp reduction in sales at the value-for-money bakery chain. Brexit and its potential inflationary impact on ingredient prices could prove another blow, and Greggs’ shares have recently been giving back some of the gains clocked up following last month’s positive vaccine developments. 

But the trading environment during the pandemic has also allowed the group to focus on some strategic priorities for its next phase of growth. Control of its supply chain puts Greggs in a strong position to deal with future challenges, too. Meanwhile, the travails of rivals could set it up for a glorious revival in the years ahead.

On a (sausage) roll

To appreciate Gregg’s post-Covid opportunities and potential, it’s important to understand the strategy the group has successfully established and evolved since Roger Whiteside was appointed as its chief executive in 2013.

When Mr Whiteside joined Greggs, the baker looked like it had lost its way. Like-for-like sales had been negative for two years while profits had fallen by more than a fifth over the same period. Meanwhile, the underlying pre-tax profit margin had tanked from 7.9 per cent in 2010 to 5.4 per cent in 2013.

After a strategic review, the decision was taken to halt overall shop growth for two years and focus instead on developing products to sell into the fast-growing food-to-go market. Greggs also began to shift its shops away from high-street locations where footfall has continued to decline. The actions taken laid the foundation for the exceptional growth experienced by the business over the last five years. Essentially, Greggs has grown sales by offering people more of the grub they want, at great prices, in the right locations, and for more hours of the day. 

At the same time the company has focused on squeezing out operational efficiencies. This has been a key focus over recent years. It has moved baking out of its shops and into state-of-the-art, centralised facilities. The supply chain push really got serious in 2016, with £100m of spending committed up to mid-2021. So far the improvement in product quality and efficiency resulting from this investment has exceeded expectations. 

Greggs increased control of its supply chain has also allowed it to respond more quickly to changing tastes. It has had huge success with new products, such as its vegan sausage roll.

The success of the strategy is reflected in key fundamentals. From 2014 to 2019 like-for-like growth has averaged 4.9 per cent, ranging from 2.3 per cent to 9.2 per cent last year. This has meant a 23 per cent increase in store numbers since 2013 to the end of 2019, which has been amplified into a 53 per cent rise in turnover. Meanwhile, efficiency improvements and the fact each shop has a large proportion of fixed costs has magnified the impact of the sales growth on profits, with EPS soaring 193 per cent over the period. 

Improvements in margins and returns on money invested in the business – key measures of business quality – underline the fact that the company has become an increasingly attractive investment proposition over this time (see chart 1). This is all the more impressive given that Greggs has faced noteworthy cost inflation, not least for staff which account for two-fifths of overheads.

The cooling rack

The question now is whether this excellent investment story can re-establish itself as pandemic restrictions ease. The hit from lockdown has certainly been harsh. 

First-half sales plummeted 45 per cent and the company reported an underlying loss of £64.5m. Meanwhile, excluding lease liabilities, the balance sheet showed £26m of net debt at the mid-year compared with net cash of £85.9m 12 months earlier. That said, the company did make a special return of £35m in the 12 months and was back to net cash by September this year. It also has access to £150m of government-backed credit. 

Greggs has significantly scaled back its growth plans, with 20 net openings expected for the year compared with the 100 it had previously pencilled in. Meanwhile, after cancelling its final dividend payment for 2019, the payout will stay off the agenda for the time being. But a record of strong cash generation suggests a reinstatement of dividends may not follow too far behind any sales pick up. Average free cash conversion over the five years to the end of 2019 was over 90 per cent; a very healthy level.

The impact of the second lockdown should also have been much less severe than the first as many shops have been kept open. 

Importantly, Greggs may not have as much to fear as rivals from possible changes to consumer habitats in a post-Covid world. For many food-to-go businesses, a key concern is that increased working from home will mean a permanent reduction in demand. This seems less of a threat to Greggs based on its customers and shop locations (see chart 2 & 3). Indeed, most Greggs fans that do work need to go to their workplaces. And its value-for-money credentials could prove defensive if the post-pandemic economy is sluggish.

The strength of Greggs’ position is underlined by the fact that a recently announced plan to cut 820 jobs – about 3.5 per cent of the 24,000 strong workforce – is well below cuts announced by rivals such as Pret a Manger and SSP. This is particularly encouraging because the company’s operations seem to have benefited from the staff loyalty it has created through policies such as its 10 per cent employee profit share.

So even if the 'new normal' is a bit different than the old one, Greggs should prove well placed for recovery. Meanwhile, having gone into the crisis with a robust balance sheet and supply-chain improvements already at an advanced stage, when trading starts to pick up it has the potential to steal a march on weaker players, which include many independent operators. “We know that [sector] supply will be down,” says Peter Martin, creator of pub and restaurant data service Coffer Peach Tracker. “This is still going on so we don’t know by how much, but it could be a hell of a lot.”

Oven ready

The group has continued to move ahead with key aspects of its long-term strategy during the crisis, which should also serve it well as life returns to normal.

It is on course to finish the transformation of its manufacturing, but it has slowed down some of its capacity growth plans in line with reduced store opening. It will ultimately have the capacity to support 2,500 shops compared with the current estate of 2,050, which includes 307 franchise shops.

And while lockdown may have been painful for the business as a whole, it has provided an ideal launch pad for a recently announced digital push, which the company views as central to the next phase of its growth. 

Greggs’ success since 2013 has been based on attracting more 'walk in' customers. It now wants to seek out customers online by offering click-and-collect and nationwide delivery through a partnership with Just East. All its sales channels are being brought together through its loyalty scheme. 

The digital change is getting under way at a time when many customers either don’t want to go out, or want to spend minimal time in a shop. And given the company's status as the UK’s most popular dining brand, based on YouGov research, it looks brilliantly placed to compete online where brand matters more than physical location. 

At the end of September Just Eat had rolled out the delivery service to about 300 Greggs shops, or 15 per cent of the total, and in the latter weeks of the month the baker generated 2.6 per cent of sales from delivery. 

What’s it worth?

There is a question about how to value Greggs’ shares given the uncertain outlook: have long-term prospects been permanently impaired or can investors look to the past as a guide to post-pandemic prospects? While it is impossible to be sure, on balance we see a decent chance that the group will come back strongly in 2021. Not only does its customer base look resilient, but it should benefit from the travails of competitors and the timing of a digital push that should improve the potential to create extra value from the brand. Indeed, the recovery for Greggs could prove more rapid than the market currently expects and, further out, growth prospects may have actually improved. Greggs' control of the supply chain could also make a messy Brexit, along with cost inflation, easier to manage.

The shares are currently priced at 1.5 times historic 2019 sales, which compares with a valuation of over 2 times before the pandemic struck. While 2019 sales and profits may currently seem a distant memory, it’s feasible that 2022 could see trading in this ball park again. That should focus investors’ attention on the longer-term merits of recent supply chain investment and the new digital push as 2021 progresses.