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Greggs on a roll

The baker has nailed the transition to on-the-go specialist
June 6, 2019

Greggs (GRG) has been aiming its business at the 'food-on-the-go' market in recent years, leading to strong like-for-like growth and repeated profit upgrades. Some are tempted to say there's limited scope for the UK's much-loved bakery chain to grow given the size of its estate, but we believe the group's recent innovations hold the key to further riches.

IC TIP: Buy at 2,114p
Tip style
Growth
Risk rating
High
Timescale
Medium Term
Bull points

Strong return on investments

Expanding into delivery and click-and-collect

Recent profit upgrades

Special dividends expected

Bear points

High valuation

Limits to estate growth

Greggs is fundamentally a simple business. It makes and sells a range of food products – predominantly baked goods – across the UK. It makes a proportion of its revenues from wholesalers and franchisees, but more than 90 per cent of sales and profits come from the retail outlets it operates.

In 2013 the group announced plans to turn from a bakery into a food-on-the-go giant. One reason for this shift was declining like-for-like sales. Changes paid immediate dividends. Following a 0.8 per cent like-for-like decline in 2013, the group shifted to 4.5 per cent growth in 2014 and has been in positive territory since. Growth was softer in 2018 at 2.9 per cent, but the first quarter of 2019 has been very promising.

Greggs' ongoing repositioning strategy involves store refurbishments, new openings away from the high street, initiatives to improve speed and quality of service, and significant investments in supply chain and systems. So far, the plan has seen the group's store estate rise from 1,671 to 1,969 (including 269 franchises), with plans to break 2,000 in 2019 and build supply-chain capacity to support 2,500 by mid 2021. While associated investment has seen the capital employed by the group rise in recent years, margin improvement and sales growth have meant returns on that capital have risen at the same time (see chart below).

 

At the heart of Greggs' success has been innovation. The company has moved away from the high street, with recent new openings focused on high-footfall travel locations, such as Birmingham New Street and London Bridge stations. Meanwhile, it started to open drive-thrus in 2017.

Supply chain improvements have also helped the group drive more sales by extending opening times and ranges. Early success here is evident in its focus on strategic categories such as the breakfast time slot, hot food and drinks, and healthy options. Sales in these new categories accounted for 36 per cent of the total last year, and management is attempting to replicate its success later in the day with a £2 pizza-slice-and-drink deal after 4pm.

The company has also proved adept at spotting consumer trends. The launch of Greggs' headline-grabbing vegan sausage roll helped contribute to like-for-like sales growth of 11.1 per cent in the first 19 weeks of the year – albeit flattered by soft comparisons due to last year's 'beast from the east' snowstorm. This positions Greggs to ride the growing trend towards meat alternatives, which research from the European Regional Development Fund estimates will grow 6.8 per cent annually until 2022. The company's commitment to waste reduction and responsible sourcing also plays to evolving consumer expectations.

While at an early stage, the group's experiments with click-and-collect and delivery hold compelling commercial potential. Greggs has been working with online food delivery start-up Deliveroo to test home delivery in Birmingham, Newcastle, Bristol and London. The online food delivery sector is growing rapidly and offers enormous potential. An indicator of how delivery could work for Greggs comes from McDonald's, which generated a tenth of sales from delivery in 2018 using a rival platform. McDonald's rapid delivery growth has been attributed to the fact that the large size of its estate facilitates very fast delivery times; Greggs' estate is 700 stores larger.

The overhaul of Greggs' supply chain, plans for around 100 openings a year and ongoing product innovation does not come cheap. Capital expenditure is expected to come in at £90m this year and then £80m-£90m a year over the medium term. However, we think the results from this investment should continue to be impressive. What's more, despite the spending, the company is generating more cash than it needs, with net cash well ahead of management's £40m target level compared with £88m at the end of 2018. That means a special dividend is expected to be announced at the half-year stage, with further special payouts forecast thereafter (see table).

GREGGS (GRG)   
ORD PRICE:2,114pMARKET VALUE:£2.14bn
TOUCH:2,114-2,116p12M HIGH / LOW:2,190p939p
FORWARD DIVIDEND YIELD:3.2%FORWARD PE RATIO:23
NET ASSET VALUE:325pNET CASH:£88.2m
Year to 29 DecTurnover (£bn)Pre-tax profit (£m)*Earnings per share (p)*Dividend per share (p)*
20160.8978.159.131.0
20170.9681.363.132.3
20181.0389.870.335.7
2019*1.1611387.595.2
2020*1.2311591.167.6
% change+6+2+4-29
Normal market size:1,000   
Matched bargain trading    
Beta:1.87   
*Shore Capital forecasts, adjusted PTP and EPS figures, DPS includes special payments