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Fri 14th Oct 2016 - Analyst: Whitbread’s Costa Coffee aims to break even in China by 2020
Jamie Rollo – Whitbread’s Costa Coffee in China aiming to break-even by 2020: Morgan Stanley leisure analyst Jamie Rollo has reported that Costa Coffee is aiming to break-even in China by 2020 – it currently has 400 stores in the country. Reporting on a field trip to China in which a meeting with Costa China managing director Esteban Liang was held, Rollo said: “Coffee is one of China’s fastest growing segments, alongside fast fashion and luxury. The average consumption is just four cups per head versus circa 1,000 in Norway! The China managing director confirmed that China is a core part of Costa’s international business. Whitbread’s new chief executive office Alison Brittain has been reviewing the group’s international operations, and Costa also has a new managing director (Dominic Paul), so both seem to have concluded that China will remain a priority market. The China managing director did not comment when we asked whether it was possible to buy out either/both of its two JV partners, and we got no sense that the partners are reviewing their stakes. Costa China is very focused on pushing its different customer offer relative to Starbucks: handmade coffee rather than push-button, its British heritage, and well-invested stores (trendy, modern, stylish). Its customers tend to be very aspirational, with a small coffee costing c. RMB 30 (£3.50), so more expensive than in the UK. Food capture is low as the Chinese tend not to eat lunch in coffee shops. So coffee consumption at the moment seem to be all about the experience, meaning the quality of the store and service standards are key. Costa’s brand proposition is different in China to the UK, where Costa pushes its Italian heritage, slightly underprices peers, and is increasingly focused on its food product. Costa targets 700 stores to be open in China by 2020 versus circa 400 currently. It plans to open 50-60 net stores this year, and opened ten net in Q1, so if this run-rate continues it should be close to its target. It originally targeted 500 by Feb-16 and 700 by Feb-2018. It closed 25 stores last year and expects to close another circa 20 as it exits some tertiary cities and focuses on around 15 top tier cities (it is currently in around 30 cities), and as some shopping malls appear likely to close due to overbuilding (c. 50% of stores in malls). Around one quarter of its stores are in Shanghai and one quarter in Beijing. It recently added SSP as a franchise partner for Chinese airports. The company is considering introducing Express machines, though noted service stations have not traditionally been used for F&B, and also we think there might be an issue with the JV partners whose contract covers retail outlets only and thus might lose out to cannibalisation. Starbucks plans to open circa 500 stores in China this year, and now has more than 2,300, with plans to reach 3,400 by 2019. Costa has lagged this, with its net opening rate falling from 73 in FY14 to 39 last year. However, no one else is keeping up with Starbucks, and Costa still seems to be the second largest international operator in China. In addition, we heard that there are many independent stores opening under coffee’s “third wave”. Costa’s like-for-like sales have been in modest decline as a result, as stated at the Q1 trading update, though management was hopeful this would improve as it is investing in more marketing, products, digital solutions, service and new store designs. Although the managing director cited strong cost control, this, plus high labour and rental cost inflation, suggest that like-for-like profits are likely in decline. Costa hopes to break even by 2020, though it is worth noting that 2012 was originally the target. The business is profitable at the store level, and at its investor day in 2013 showed mature store economics averaging £28,000 Ebit per store for its c 50% share in the JVs. This implies steady state Ebit of £10m on last year’s average store count of 360, and given China loses an estimated £1-2m, central overhead and internal cost allocation must be £11-12m. Assuming Costa can get to 700 stores, continues to generate £28,000 per store on all its stores (despite falling like-for-likes), and its overhead remains at £12m, the bull case seems to be £8m Ebit. This is 5% of current UK Ebit, so the business will remain very UK-centric.”

McDonald’s announces $130m charge: McDonald’s has announced that for the quarter ended September 30, 2016, it expects to incur approximately $130 million in pretax charges, or about $0.12 per share on an after-tax basis, consisting of restructuring and non-cash impairment charges related to its refranchising initiatives. These initiatives were outlined in November 2015, including plans to refranchise 4,000 restaurants by the end of 2018 and a net G&A savings target of $500 million, the vast majority of which is expected to be realized by the end of 2017.

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