Greggs Plc.(LSE: GRG) is a ‘food on the go’ bakery chain retailer in the UK. The company has displayed wonderful fundamentals, compounding at consistently high rates over the past 10 years. Minimal debt and market leading profit margins further boosts Greggs long runway.

Greggs is currently in the Watchlist category, purely based on a valuation basis. In order for a fair price to be established, an approximate 30% reduction in the market price would be required. Nonetheless, if patience is applied an investor can buy into this wonderful business operation at a fair price and hold it over the long haul.

1. Vigilant Leadership

Quantitively:img_0218

img_0216Source: Annual Reports 

Qualitatively:

Annual Bonuses

  • The maximum annual bonus for management is 125% of base salary.
  • Based upon relevant finanical KPI’s.

Performance Share Plan

  • The maximum is 120% of base salary.
  • Measured over 3 year periods.
  • Based upon Total shareholder return, Return on Invested capital and Earnings per share growth.

2. Long Term Prospects

Persistent Products:

Greggs operates today as a well established bakery chain, suitably placed to react as the UK’s eating habits adapt over time. Consumer behaviour is changing more towards ‘food on the go’ with free time for breakfast and lunch being squeezed out of the working day.

Greggs is the leading bakery food on the go retailer in the UK, with over 1,750 retail outlets, which has been increasing at a compounded rate of 2.7% per annum. Greggs long term future prospects are further strengthened by consistently obtaining the highest profit margins in its industry, and therefore giving Greggs greater flexibility in long-term growth.

In addition, Greggs sales growth has grown 4.7% compounded annually, whilst the number of stores has grown only 2.7% compounded annual over the preceding 10 years. Implying that the company is finding methods to maximise greater profitability from exisiting stores and consequently churning out higher sales.

Technological advancements:

  1. Forecast based staff scheduling, time and attendance systems:

Greggs extensive employee roster (over 19,000 employees) increases the importance  for the company to manage their employees efficiently. Such technological advancements provides greater efficiency in staff operations, as the consumer cyclical nature of the industry may cause fluctuations in sales.

Weaknesses/Risks:

  1. Business change – Changing from a decentralised bakery, towards a centralised modern food on the go brand will require restructuring, capital expenditures and new systems.
  2. Product quality and safety – Greggs owns its manufacturing and supply chain and freshly produces food on premises. This operating model exposes the company to greater food safety risks and regulations.
  3. Market pressures – Changing shopping habits away from the high streets.
  4. Consumer trends – Increasing consumer concern for health and nutrition.

Solutions to risks:

  1. Regular updates are provided to monitor progress against clearly defined timelines and financial forecasts.
  2. Procedures are in place and are supported by robust audit processes, both internally, and by regulatory bodies.
  3. Greggs operates a leasehold shop estate with typically five-year break provisions, allowing them to change locations in line with customer traffic trends.
  4. Greggs has extended the product range choice to include healthier options branded as ‘Balanced Choice’ which is growing rapidly.

3. Stable and Understandable Business Economics

Stability

img_0212

 

 

 

Source: BuffettBooks

Understandable Business Economics

Industry

Greggs Plc. Operates in the UK bakery product retailing industry. The industry has performed relatively well over the past 5-10 years, although changing consumer behaviour has seen some firms slip and struggle. Nonetheless, higher demand for read-to-eat meals has driven sales in this industry heavily. Industry revenue has grown 3.3% compounded annually over the past 5 years and is expected to grow closely to the UK GDP forecasts over the succeeding 5 years.

The bakery retailing industry is labour-intensive, especially those that freshly produce food (at health and safety standards) on premises, which therefore requires more skilled employees.

Rank in industry

Greggs is the leading UK food on the go bakery retailer.

  • Supermarket Industry total revenue (2016) = £ 160 Billion
  • Bakery Industry total revenue (2016) = £ 2 Billion
  • Greggs total revenue (2016) = £ 828 Million

Business segments

1. Franchise, retail and wholesale     2. Food on the go     3. Bakery products

Barriers to entry

* Economies of scale      * Established distribution channels     * Limited retail store locations      * High labour costs      * Established supply chains

Competitive Advantages (MOATS !!!)

  1. Leading UK bakery retailer 
  2. Highest Profit margins against competitors 
  3. Consistently high return on equity and net tangible assets
  4. Brand loyalty 
  5. Strong cash generation (Free cash flow 
  6. Dominating the ‘Food-on-the-go’ niche

Major Competition

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Funding and Income:(2016)

  • Total equity = £ 266 Million of which, Retained Earnings = £ 250 Million
  • Trade payables = £ 92 Million
  • Net income = £ 57 Million
  • Free cash flow = £ 38 Million
  • Net borrowings (debt) = N/A

Greggs is able to use its strong earnings (income) power to finance its operations and capital expenditures as opposed to using debt financed growth. In addition, Greggs can operate under a lower current ratio sustainably as its consistent earnings power (boosted by high profit margins), along with strong free cash flow generation is able to cover the short term obligations.

Growth Prospects

  • Expanding the wholesale and franchising business.
  • Opening new retail stores in more convenient areas.
  • Developing stronger pipelines for new product developments.

4. Price to Valuation

From computing both an earnings valuation and a discounted future free cash flow model valuation of Greggs Plc. and discounting them back to today’s present value, using a 6% discount rate and 12% perpetuity rate to be Intrinsically valued between £ 8 – £ 10 per share, which equates to £ 824 Million – £ 1 Billion for the entire company. The future expected growth of the bakery industry and of Greggs Plc. individually was taken into consideration in this valuation.

The current market psychology and the overall valuation of UK stocks as an asset class, is pricing Greggs relatively high in between this indicated intrinsic value. Therefore, an approximate 30% reduction ( £ 7 per share or £ 724 Million) would be required to satisfy a purchase into this wonderful compounding business operation to ensure an excessive price is avoided.

Anything misunderstood, view the definitions here.

Thank you for reading, if you enjoyed this analysis then view more content here.

Jordonlee W. Smith

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