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Morning Briefing for pub, restaurant and food wervice operators

Mon 8th Feb 2016 - Jamie Rollo – Costa Coffee has 50% Ebit upside potential
Jamie Rollo – Costa Coffee has 50% Ebit upside potential: Morgan Stanley leisure analyst Jamie Rollo has argued that Coast Coffee has 50% Ebit upside potential. Rollo, who increased his price target to 5600p from 5100p, said: “Our deeper look at Costa lifts the lid on 50% Ebit upside via innovations like Pay & Collect, improved food, differential pricing, and untapped demand. Whitbread has some weak spots (e.g. London hotels, so we cut EPS 5%), but Regions are solid, cost flexibility sizable, and valuation appeals. A detailed examination highlights multiple levers not on investors’ radar: It is trialling Costa Collect, a pay and collect app which could be transformational (less queuing, more loyalty, extra sales, improved productivity – see our comparison with the sizable US gains for Starbucks) and an improved food offer. The food capture rate is 60-70% at its Fresco trial site versus the 42% Costa estate average, and a fresher/healthier range could boost lunch trade where Costa is weak. It also recently put through a price increase and is considering differential pricing, an opportunity to price up in London / travel hubs. Costa also has untapped demand, as circa 20% of its UK stores are at full capacity, suggesting upside from additional sites. We estimate ~£80m Ebit from these, +50% to Costa’s Ebit, with our forecasts only capturing expansion and 3% like-for-like sales. We trim FY17-19 EPS forecasts c. 5% due to weak London hotel trading (post Paris attacks), dull high street trading for Costa, and we assume £10m extra operating costs / D&A with the new CEO’s focus here. We assume c. 2% like-for-like sales and RevPAR in 4Q16 and FY17, with expansion driving all of our forecast EPS growth. Our PT moves from £56 to £51. UK Hotel trading is better than it appears. London RevPAR is down since the Paris attacks, but Regional RevPAR is still positive, and real Regional room rates are still 12% below the 2007 peak. Supply growth in the regions is low (c. 1.5%), the UK could see a ‘staycation’ boost this year (weaker GBP, overseas terrorism, elections, UEFA championship), Premier Inn’s high occupancy suggests plenty of untapped demand, and more to go on yield management. Flexible cost base and capital allocation options. Whitbread’s Ebit margins have been in a stable 18.5-19.5% range for a decade, and if things get worse we see potential for a £50m cost reduction programme, reduced capex spend, and even a rolling sale and leaseback programme to fund expansion. We value Costa at £4.2bn (15x Ebitda), so Whitbread’s EV of £8.4bn implies Hotels and Restaurants is £4.2bn (7.0x Ebitda, 9.0x P/E), or a ‘free’ opco value if the £5bn real estate were stripped out.”

Jamie Rollo – food is a £30m Ebit opportunity for Costa: Morgan Stanley leisure analyst Jamie Rollo has argued an improved food offer is a £30m Ebit opportunity for Costa Coffee. He said: “We recently toured the Costa Fresco trial site with management. The concept is more food oriented than a standard Costa, with a kitchen preparing freshly baked products. It aims to capitalise on the blurring of the lines between coffee shops and grab and go outlets such as Pret a Manger and Greggs which are moving into coffee, whilst using Costa’s heritage and strong brand. Currently, Costa’s food offer is oriented to sweet treats and centrally produced paninis, and it underindexes on food in the key lunchtime day part, and is missing out on the trend to more freshly-made and healthier food. The Fresco site is a converted standard Costa store in a very competitive part of Central London, and can be benchmarked against its performance before conversion. Early indications sound encouraging, with the food capture rate at 60-70% in the Fresco store against 42% in the wider Costa estate (i.e. a 50%+ higher food take up), and overall sales up despite lower coffee sales. Management are particularly pleased with food sales in the key 11am-2pm period, which gives them encouragement they can compete in the freshly prepared food space on a wider basis. Fresco needs c. 1,800 square feet to work due to the kitchen, against 1,400 for an average standard Costa currently, so only some can be converted (in the tens of unit according to management). However, Fresco could become a larger part of Costa’s opening programme, and most importantly should help Costa improve its food product in all of its stores. The company already plans to open another Fresco store in Milton Keynes. Costa’s food capture has been static for several years at 42%, and food is only 30% of sales, when we estimate it is nearer 70-80% for the more food-led chains such as Pret a Manger and EAT. We think there is scope for Costa to bring its food mix up to 40% of sales, which would imply a 30% food sales increase. Food gross margins are lower than on coffee (50-60% vs 90%), but this would still mean at least a £30m Ebit opportunity.”

Douglas Jack issues ‘Buy’ note on Domino’s shares as franchise earnings rise to £149,000 Ebitda per store: Numis Securities leisure analyst Douglas Jack has issued a ‘Buy’ note on Domino’s shares with a target price of 1200p. He said: “December’s update confirmed strong trading and the board’s comfort with current market expectations. Given this and the JV solution for Germany, the 3 March final results should focus on the UK’s strong growth prospects, which are indicated by ongoing double-digit like-for-like sales growth (particularly in digital), accelerating expansion and rising franchisee profitability. Domino’s dominates a market in structural growth. According to The Pizza, Pasta and Italian Food Association, the pizza delivery market grew by 8% to £1.1bn in 2014. We estimate that the UK market (worth £741m for carry out and delivery in 2006) has grown at a 9% CAGR over the last eight years, with Domino’s growing system sales at a 16% CAGR, and accounting for 73% of the market’s growth over this period. Two years of double-digit like-for-like sales growth are providing a clear signal that the UK market is not mature. Domino’s last reported having 26,000 households per store vs 16,000 in the US and 19,000 in Australia, countries that have significantly higher household penetration and order frequency than the UK. They are also expanding and generating double-digit like-for-like sales growth. Like-for-like sales and franchisee margins are benefiting from strong growth in digital sales, largely via mobile apps. Combined with lower food costs, this helped franchisees to make an average of £149k of Ebitda per store in H1 2015, up from £102k in 2013. Our 2015E forecast of £155k of Ebitda per store equates to a 62% average cash return. Franchisees are recycling much of this extra profit back into the system through greater expansion (55 stores opened in the UK in 2015) and local store marketing. These both drive volumes, which improve efficiency and margins, as well as increasing the National Advertising Fund, which boosts like-for-like sales, in a virtuous circle. Domino’s shares are valued on a 2016E P/E of 24.6x, slightly above the 24x historic average, with 2016E forecasts having scope for upgrades, in our view. Our 1200p/ share target price is based on DCF, applying assumptions of no share buy backs and just 1% growth into perpetuity. We believe the company is undervalued given its net cash position, minimal capex, zero net rent, as well as its high returns and long-term growth potential.”

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