Greggs taste test wins over our shares analyst

by Richard Beddard from interactive investor |

The rise of Greggs has been quite remarkable, and our companies analyst has been converted.

One of my worst traits as an investor is that I like to discover shares myself rather than find out about them because they are so popular. There is a good reason for this, popular shares are generally expensive, but it leads me to neglect them, which is a mistake. 

Sometimes their popularity is well-founded, and they are not actually over valued at all. And stock market valuations are capricious. Sometimes traders lose faith in a business for the wrong reasons and long-term investors can pick up a bargain. To do that though, we need to appreciate the business.

While I am in a confessional mood, I should also own up to a smidgen of snobbery. I am more of a southern softy Pret-a-Manger kind of guy, and the sight of flaccid pastry in a Greggs (LSE:GRG) warming cabinet does not fill with me with the joy it so obviously engenders in my Geordie mates. That bias, too, may have relegated Greggs down my to-do list.

Greggs is popular, especially in the north, and that may have led me to ignore it. Many of its approximately 2,000 stores have been converted in the last five years from individual bakers shops to a network of fast food outlets supplied by centralised bakeries, a change in strategy that has improved its results and continued its long history of profitable growth. 

Its expansion has taken it out of the high street and into airports, stations, and motorway services. A home delivery trial is bringing sausage rolls to people’s doors.

The gradual realisation I have neglected a thriving business propelled me to the unfashionable end of town on a cold day a couple of weeks ago, where I sampled Greggs’ new vegan steak bake while sitting next to a kind old lady, who offered me the sports pages of The Sun and complained at the unkindness of other customers every time they left the door open. 

In Cambridge, Greggs is sandwiched between a Little Waitrose and an Argos, and opposite Shoe-Zone, where I have previously marvelled at how a company can sell shoes for the price of insoles and insoles for the price of laces. Shoe Zone is next to CEX (Entertainment Exchange) and Game. Waitrose is clearly the outlier in this gaggle of pile it high, sell it cheap outlets, but the steak bake was tasty, especially the pastry which was not flaccid at all. 

Source: The author’s phone

Because Greggs is not one of the 30 companies I follow most closely, I haven’t yet got an archive of historical data going back many years. Instead, I have extracted the data for 2018 and 2017 from the company’s latest annual report, and calculated the key financial ratios for the most recent period we have full financial data, the year to December 2018. 

    Enterprise value (£m) Year end Revenue Growth (1y) Adjusted Profit Growth Profit Margin Return on Capital Cash Conversion Gearing (incl. lease obligations Yield
GRG Greggs 2,588 Dec-18 7% 9% 8.50% 14% 97% 46% 3%

Source: Calculations by the author from data in Greggs' 2018 annual report

These numbers are, of course, already out of date, as Greggs’ financial year concluded in December 2019. In January, the company gave investors a taste of what they can expect when it publishes preliminary results on 3 March and the annual report in April.

It’s been a fabulous year and the announcement reinforces the perception that Greggs is an admirable business. The announcement starts with a “special thank-you” to staff, who will by the time you read this have been paid a one-off bonus worth £7 million. Every year it shares 10% of profit with employees, and at least 1% of profit with the Greggs Foundation which supports good causes including free breakfasts for primary school children. 

Greggs is sharing the spoils of its exceptional year, which should help retain inventive and courteous staff and secure long-term prosperity. It’s also returning surplus cash to shareholders, who will receive a special dividend for the second year running. 

In numbers, Greggs says revenue increased 13.5% in 2019, helped by the fact that it had nearly a hundred more shops, but also by 9.2% revenue growth at established shops. Though I take a dim view of any company describing its sausage roll as “iconic”, Greggs says the vegan version, introduced in 2019, is hugely popular and demand is growing alongside demand for the traditional range. Greggs has plans to offer more dietary choices, including vegan doughnuts, in more outlets. The “once in a generation” investment programme embarked on six years ago and now near completion, will enable it to supply 2,500 shops, compared to 2,050 at the end of 2019.

There you go, I probably haven’t told you much you didn’t already know about Greggs, but at least it is on my radar now. I cannot tell you much you cannot work out yourself from the numbers either, but I’m not too worried about Gregg’s 8.5% profit margin. My numbers are calculated after corporation tax, unlike most sources, and 8.5% margins are high for a company that sells low priced goods in such volumes. 

I suspect Greggs’ profitability stems from the fact the company owns much of its supply chain and distribution network, i.e. it makes its own bakery products and sells them in its own stores, which probably helps with efficiency and innovation. Selling fresh products from its own bakeries, for example, means it uses less packaging than competitors. More than 90% of revenue comes from its own stores, and the other 10% from wholesalers and franchisees.

As the company admits, vertical integration is a double-edged sword. In the event of a dramatic decline in revenue, Greggs will still have to bear the high fixed costs of its bakeries and shops or make painful cuts. But Greggs earns relatively high margins and has no debt, so it should be fairly resilient, and the food and drink is inexpensive, so people might gravitate towards Greggs when money is tight. The benefits of vertical integration in most years, probably outweigh the risks in a recession.

Aside from the fact that most of Greggs’ numbers are moving in the right direction and cast the business in a good light, they’re also untainted by accounting shenanigans. There is no goodwill or acquired intangible assets on Greggs’ balance sheet to complicate the accounting, and although I reckon the company is 46% geared, that is entirely due to lease obligations. 

The share count is stable over the years, so by any reckoning it’s a self-reliant business growing simply by reinvesting capital in new, often healthier, products, more efficient facilities, and more outlets.

The valuation is slightly more concerning, although largely outside Gregg’s control. An earnings yield of 3% is equivalent to an enterprise multiple of about 30 times adjusted profit in 2018. While Greggs will make more profit in 2019, I am not in a hurry to promote it to the Decision Engine at the expense of one of its existing members. I imagine that that day may come, though.

Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard.

Richard Beddard is a freelance contributor and not a direct employee of interactive investor.

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