An impressive set of full year 2023 results released by the British food-to-go bakeries and coffee retailer, Greggs PLC (LON: GRG).
Strong trading results
During a year when the British economy grew by just 0.1%, Greggs experienced total sales growth of 19.6%, and like-for-like sales growth of 13.7%, which is impressive, despite dropping off from 23% and 17.8% respectively from 2022. Importantly, sales growth was well ahead of the 8.5% inflation incurred by Greggs in 2023.
Unpicking the sales performance, total sales from the company managed shops (existing plus new stores added during the year) grew by 19%, whilst B2B sales grew 23.8%. B2B includes the commissions received from its franchise partners and sales of Greggs branded products to Iceland supermarkets. The strong sales to franchise partners reflects the company’s strategic thrust to increase growth through these routes, and to increase its presence at roadside locations, retail parks and “store-within-a-store” retail partners such as Tesco, Sainsburys and Primark.
145 new stores, net of closures, were added to the Greggs estate during the year, bringing total stores to 2,473, of which 500, or 20%, are franchised.
Slight drop in gross profit margins as input costs continued to escalate
Gross profit margins declined by 1.3% points, as the company felt the effects of input costs outpacing its ability to pass the costs on to customers, increased sales through delivery channels where commissions and costs are higher, as well as the Greggs App, where customers get every 10th purchase free, which works out to a 10% discount thus reducing margin. Still at 60.7%, the gross margin remains strong.
Operating costs were contained well as GG&A costs remained at 51% of sales, leaving operating margin at 9.5%, a drop off from 10.2% in 2022 because of shrinking gross margins. Included in operating costs is the 10% of PBT profit share which is paid to employees.
Benefiting from elevated interest rates
A number I want to drill down into is finance costs. Finance costs decreased from $6m to $4m during the year. Finance costs mainly relate to IFRS 16 interest charge on lease liabilities of £9.6m, offset by £6.3m income on cash deposits. Greggs strong balance sheet, with no long-term debt other than leases, and a large cash pile, has enabled the company to earn strong interest from its cash deposits in an era of elevated interest rates, where more levered companies are struggling with higher interest payments.
Underlying PBT increased from 148m to 168m, an increase of 13.5%. This excludes once-off exceptional income of £20m relating to COVID business interruption and flooding claims.
UK corporation tax rate increases
Effective corporate income tax rate increased to 24.3% up from 18.8% due to the increase in UK corporation tax rate from 19% to 25%. Going forward, CFO Richard Hutton has given guidance that the company’s effective income tax rate will be 26%.
Excluding the exceptional income, underlying EPS increased by 5.3% from 1.19 to 1.25 per share, an increase of 6.4%.
The dividend per share increased by 5% from £0.59 to £0.62 per share, although like 2021, a special dividend of 0.40 per share was announced as a return of surplus cash to shareholders, resulting in a total dividend of 1.02 per share for the year. This represents a dividend yield of 3.4% on the current share price.
Balance sheet analysis
Turning to the balance sheet, the ratio that stands out is the ROCE of 21%. Given the estimated WACC of the company of around 10%, this illustrates strong value creation by the company.
Sizeable capex to fund strategy
The company invested almost £200m in 2023, up from £111m in 2022, as it implements its strategic thrusts of investing to expand supply chain and distribution facilities, and open new stores, refurb or relocate existing stores.
What I really like about Greggs is that it is investing strongly when other companies are hesitating. There is no talk of blaming Brexit, high interest rates or waiting on the outcome of the general election before making decisions. They have a clear strategy, strong balance sheet and cash generation, and are forging ahead to implement their strategy.
Strong working capital position
The company’s working capital is well managed, with supplier funded payables covering its investment in receivables and inventory to the tune of £108.5m, which is an enviable position. However, due to its strong cash balance of £195m, the net working capital position including cash, is 86.8m, showing adequacy to settle obligations when due. The cash balance is excessive, but it meets the company’s policy of having at least £50-60m cash on the balance sheet at year end, to get it through the seasonal strain on working capital come mid-year when dividends and corporate tax payments need to be made. And it means the company can get going with funding its capex requirements with internal resources.
Low debt
What I really like about Greggs is the lack of long- or short-term bank debt on its balance sheet. The only debt it has relates to IFRS 16 lease payments, which when included in its capital structures gives a gearing ratio of 33%. I’d like to see the company consider taking on more debt, to fund its strategic plan. This is because the company is earning ROCE of +20%, when its WACC is 10%, and will probably drop if interest rates decrease later in the year.
Cash-Flow
Net cash flow from operating activities after working capital changes and principal lease payments (rent) was £257m, up from £199m, which is 87% of estimated EBITDA, showing strong earnings quality.
Share buybacks
£5m of cash was used to buy back its own shares. What I like about this, is that it is buying up shares which are being issued as part of company LTIP plans to incentivise management, and therefore reducing shares outstanding, therefore being value accretive to shareholders.
Strategic review
The company has a very clear strategy to:
- Broaden customer appeal – the company has made good progress here by increasing market share of the UK food-to-go sector from 7.7% to 8.2%. In the breakfasts trade, Greggs overtook McDonalds to be the number 1 market share leader with 19.6% market share. Promotions such as the coffee and a bacon sandwich for £2.85 has helped the company with this aspect.
- Grow the Greggs estate – on average 4 new stores were opened per week, giving 220 new stores, however this reduced to 145 net of closures. Over the next 4 years, the company aims to open 150 net new stores per year, which will surpass the company’s target of “significantly more than” 3,000 stores. Management specifically say “significantly more than 3,000” rather than mentioning a number, for confidential reasons I surmise. There are some concerns of the company’s presence becoming saturated, however I believe the company has a long way to go until it gets saturated. If you look at Costa Coffee, they have +14,000 stores in the UK, compared to Greggs 2,500, and I believe Greggs can continue to increase its market share as it implements its strategy. In terms of strategic focus areas, most of the store growth in the next few years is expected to come from roadside locations including petrol forecourts, retail parks and partnerships with food and clothing retailers. And when saturation does finally come, the retailer which is exclusively British focused, could look to expand geographically into mainland Europe and beyond.
- Evening trade – as part of the 5-year strategy embarked on in 2021, the company targeted evening trade (opening later than 4pm) as a key growth area. As at 2023-year end, 1,200 sites, circa 50% of total, are open till 7pm or later, and these sales comprise 8.2% of company managed shop sales. Greggs market share in this part-day trade has increased to 1.6% from 1.2%.
- Digital channels – COVID was the catalyst that caused many food-to-go retailers to extend their digital channel sales. Greggs currently has 1,440 shops affiliated with the Just Eat digital platform, and 930 shops on the Uber Eats platform. Sales through these digital channels comprised 5.6% sales, and grew by 23% from 2022.
All the above strategic thrusts are supported by significant investment into supply chain and technology.
Future investment plans
Greggs has a massive investment programme over the next 4 years, where it will invest over £800m, of which up to £280m will be invested in 2024 to expand its savoury production capacity as well as open c. 170 new stores. The balance of +£500m capex will be invested over the following three years, split roughly 50/50 between opening 620 new stores and existing store refurbs, and the other half in expanding existing production sites and enhancing distribution capabilities. The new stores opened in 2023 cost an average of £390k per shop, whilst the refits cost £135k per shop. The target cash return per shop is 25% of investment cost, so about £97,500 per new store.
I’d like to know how the company intends to fund this expansion – will it continue to used retained earnings and keep increasing the dividend in line with its progressive policy, or will it look to the debt/equity capital markets.
The ROCE, a key measure is expected to drop below 20%, in 2025/26, as the funds are invested and before the returns start to be generated, but thereafter the ROCE will rise again past the 20% mark.
Outlook
During the first two months of trading into 2024, the company said volumes were strong, but like for like sales were up only 9%, which was below previous year due to adverse weather conditions in some parts of the country. Inflation is expected to be 4-5% in 2024, down from the 8.5% incurred in 2023, so would naturally expect sales growth to not grow by the same percentages seen in 2023. However, with 145 new stores open, a stronger outlook for the UK economy, lower inflation, and continued demand for the value products which Greggs offer, I expect another stellar performance from the company.
Based on 2023 profits, at the current share price of £28.74 as of Thursday 28th March, the company trades on a trailing 12 months P/E multiple of 20 times earnings. An average of six companies operating in a similar space (McDonalds, Yum, Starbucks, Restaurant Brands International, Cheesecake Factory, and Wendys) had an average P/E ratio of 21.5 times. Based on my forecast EPS for 2024 of 1.50 per share, this results in a forward P/E ratio of 19 times.
So whilst not cheap on a price/earnings basis, the stock has a strong track record, where it has generated a return well in excess of the FTSE 250 Index (see chart below), has a progressive dividend policy generally paying 50% of earnings, has strong growth prospects and a clear strategy. For me, it is a stock to accumulate. Buying the stock today, gives an ordinary dividend yield of 2.2%, and when including the special dividend, a dividend yield of 3.6%. My target price is 32 pounds, giving a 12 month potential upside of 11%, with dividends on top.
Could Greggs reach the FTSE 100 index? The last position on the FTSE 100 is currently Ocado with a £3.7b market cap. Greggs is placed 124th on the FTSE 350 index, so 24th on the FTSE 250. For Greggs to reach the FTSE 100, ceteris paribus, it would need a share price of £36.5 per share, which is an increase of 27% from the current share price.
