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Thu 26th Mar 2015 - Analyst – we think Whitbread is set to unveil its 2020 milestones
Analyst – we think Whitbread is set to unveil its 2020 milestones: Morgan Stanley leisure analyst Jamie Rollo has forecast that Whitbread is to set out its 2020 milestone for expanding the business – he has increased his price target for shares to £58.00 from £52.00. He said: “Whitbread will likely extend its 2018 Milestones to 2020 with its Full Year 2015 results on 28 April. We think it will do this in a fairly linear fashion, and we now incorporate 85,000 UK hotel rooms (75,000 2018 target) and 4,600 Costa outlets (circa 4,000 2018 target). We publish a new 2020 EPS forecast of 375p, a 12% five-year EPS CAGR. While targets can create unforeseen consequences, high hotel occupancy levels and strong Costa like-for-like suggest plenty of expansion opportunities. Is this enough to buy the shares? We forecast this five-year expansion plan would add circa £250m Ebit, 50% on 2015e, and we also forecast circa £150m of like-for-like Ebit growth, 30% on 2015 estimates. This implies £80m average annual Ebit growth, a little above what we forecast it to deliver in 2015, a record year. Given like-for-likes will likely slow at some point, we think our forecasts are fairly generous. In which case, the debate comes down to the valuation multiple and the international plans. Whitbread’s success in the UK is well established and well understood, and it is also where it makes 100% of its Ebit. At some point the UK will slow, and success abroad will become more important. To date, the company is on track for its UK targets but behind for international, and we assess the potential upside if international succeeds. However, due to its overseas franchised model, low critical mass in equity markets, and the sheer scale and capital behind the UK businesses, we conclude neither Costa nor Premier Inn International are likely to be materially profitable, and that Whitbread needs to invest more capital, particularly in Europe. This may mean higher ramp-up losses, but the longer-term prize suggests this is a strategy worth pursuing.”

We forecast Costa and Premier Inn International moving from a £(7)m Ebit loss in 2014 to £28m Ebit in 2020: Rollo said: “We value International at close to zero today, as it makes no income, and even by 2020 this profit is only 3% of group Ebit. To some extent, Whitbread is a victim of its own success: it is simply too profitable in the UK, with a growing No. 1 market share in both hotels and coffee shops, and both Premier Inn and Costa generating higher unit profits than their peers, partly due to its high asset ownership in hotels (a legacy of its former days as a major brewer). Maybe international does not matter. But if Whitbread is to diversify, to add another leg of growth, and to prove it can get a return on its overseas investments, we think it is critical.”

Costa International conclusion: Rollo said: “Costa seems to be successful abroad, having expanded from 100 to circa 1,200 stores in the last decade, amounting to over one-third of its units. Indeed, this is the same domestic/international split as Starbucks. However, Costa International makes a small loss, whereas Starbucks generates 30% of its profit from outside the Americas. The difference is that Starbucks tends to operate stores under the equity model, whereas most of Costa’s are franchised, where the bulk of profit remains with the franchisees. In addition, Costa has had to restructure some key equity markets like Poland and China, and has seen some franchisees retrench, such as in India. It is thus well behind its target to generate 33% of system sales from international markets by 2018 (vs. 22% in 2013, with 2015 at 21%). This disappointment masks a profitable international franchise operations, potential upside from expanding into France where it has a trial, and rolling out its Express machines across Europe. We now forecast Costa International to move to a c. £30m profit by 2020, which implies it makes profits in all its current equity markets, including France (where it probably needs another year of trials before deciding to roll out). While this would be a major turnaround from its current small loss, it would still mean generates 90% of profit from the UK. We value Costa at £3.8bn in our base case (14x Feb-17e Ebitda, in-line with Starbucks), but £4.5bn in our bull case which ascribes a £0.7bn value to International. After all, if Starbucks can enjoy a $75bn EV, and generate 30% of profit from outside the US, couldn’t Costa International be worth $1bn?”

Premier Inn International conclusion: Rollo said: “Premier Inn’s international expansion has been slow and its plans seem to be in a state of flux. It targets c. 10,000 rooms by 2018 either open or in the active pipeline, with around half these mature open hotels, and has 1,700 open currently. Having originally been targeting Asia under an asset light model, it is now also targeting Germany under an asset heavy model. We can see why: the Asian business is thinly spread, behind targets, and many new managed/franchised hotels are needed to move the dial given their relatively low contribution. Even on its targets for c.50 hotels in Asia we do not see the Asian operation making more than a mid single digit Ebit contribution. Germany can be run from the UK and thus avoid additional overhead, and could make c. £15m if it gets to its six owned hotel target. However, this difference is more about capital investment than operational success, and Premier Inn Germany is likely to remain subscale with relatively lower occupancies and higher distribution costs than in the UK. At £10-20m of Ebit from Asia and Germany combined, we see Premier Inn International as only amounting to 2-3% of its UK Hotel and Restaurants Ebit. We think an acquisition of a European hotel chain could help accelerate Premier Inn’s footprint and brand presence.”

How about the UK businesses? Rollo said: “If we look back at our forecasts from three years ago, Whitbread’s trading outperformance has all been due to stronger like-for-like sales in the UK, with unit expansion broadly in-line with its targets, and International a little weaker than we expected. Much of the like-for-like performance can be put down to the stronger UK economy, which led to UK hotel RevPAR improving from 1.6% in 2013 to 9% last year, and Premier Inn’s RevPAR growth has been a little weaker than the market. Looking forward, we already factor in Whitbread’s 2018 Milestones, where it is slightly ahead at Costa and slightly behind at Premier Inn, suggesting upside surprise needs to come from like-for-lie sales. We currently forecast group like-for-like sales growth of 5.3% in 2016e and 3.5-4.0% thereafter. While this is a slowdown on 2015’s 6.5%, its ten-year average is 4.3%. Every 1% on like-for-like sales is circa £15m Ebit or 3% to EPS. So if it continues to grow at 6% for the next three years that implies £80m of additional Ebit, or an 11% EPS upgrade for 2018e. We are not sure this alone is enough upside for outperformance.”

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