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Wed 27th Apr 2016 - Jamie Rollo – more positives than negatives at Whitbread
Jamie Rollo – more positives than negatives at Whitbread: Morgan Stanley leisure analyst Jamie Rollo has reiterated an ‘Overweight’ recommendation on Whitbread shares in the wake of yesterday’s (Tuesday, 26 April) strategic update by new chief executive Alison Brittain. Rollo argued that there were more positives than negatives in the update and argued that Whitbread is “possibly the best hotel company in the world”. He said: “We remain ‘Overweight’ on Whitbread shares after digesting the FY16 results and the new chief executive’s strategic update. The figures themselves were in line, but we took away more positives than negatives. We were particularly encouraged by the confirmed expansion targets, focus on efficiencies, international clean-up, discussion of internal profit levers, and recent improvement in Costa’s trading. We are not changing our forecasts or £51 price target, and continue to believe this is one of the highest quality companies in our coverage (indeed, possibly the best hotel business in the world?), with a long runway of expansion opportunities, plenty of internal profit drivers, and capable of generating double-digit sales and earnings per share growth. There were also negatives, but as discussed below nothing new. UK stocks are unpopular ahead of Brexit, and hotel trading is poor, but we see this as temporary, and when like-for-likes start to recover (we expect from fiscal quarter two rather than quarter one in June), the stock should close its substantial conglomerate discount (cal 2017 price-earnings ratio 14.7x, EV/Ebitda 9.5x).”
 
What Rollo liked:
 
Expansion targets confirmed: “The new chief executive has ‘scrubbed’ the 85,000 2020 hotel room target (versus 65,000 currently) both bottom up (catchment areas, extension potential) and top-down (assume 2.4% demand CAGR, 3% lost to disruptors, and branded budget grows from 24% to 29% share). This implies Premier Inn grows from 9.3% to 11.5% of the total UK hotel market, and that it is responsible for around 35% of gross new room openings (assuming 0.5% annual closures), in line with the experience in 2014 and 2015. Even if this seems optimistic, the UK’s occupancy rate of 77% is the highest of any Western hotel market, suggesting it is undersupplied. The £2.5bn 2020 Costa system sales target was also confirmed, with it ahead of target in the UK but behind overseas. We estimate these expansion targets will add circa £40m additional Ebit each year or 7% annual growth. Note that around 5,000 of the 20,000 new rooms will come from extensions (the highest and safest ROI), and around 4,000 from the new ‘hub’ concept (which is trading ahead of expectations).”
 
Efficiencies moving up the agenda: “We were encouraged by the comment that Whitbread will ‘move productivity and efficiency up the agenda’ through greater automation, opportunities in procurement, and a review of supply chain and logistics efficiencies.. Specifically, the new chief executive mentioned consolidating some of its 200 technology suppliers, its 3,000-plus SKUs, and its 2,500 daily deliveries. The productivity gains will be reviewed in more detail in the coming months, with a conclusion by the November CMD, but there could be ‘reasonably large sized prizes’, with some already in guidance (and funding the extra £15m of technology opex that was mentioned at the quarter four update). If like-for-like sales deteriorate further, we think the cost saving opportunity could be a material two digit figure (it was £25m in 2008 when the company was half the size), and it is comforting to know this potential is being assessed.”
 
Cleaning up the International businesses: “Whitbread is reviewing its Hotel businesses in India and south east Asia, which lost circa £8m in FY16 (Premier Inn International lost £(4.6)m but generated a £3.3m profit in the Middle East JV). We think it is possible that management could consider exiting this business, given it says the markets remain operationally challenging and there is little synergy with the European hotel business. If it were to remove this loss and get some of the c. £50m investment back, we believe such a move would be at least 1% earnings per share enhancing. The other overseas businesses remain core, but as discussed below we still have some questions over these.”
 
Plenty of internal profit levers: “For Premier Inn, the company highlighted it is rolling out another dynamic pricing iteration, as it still sets initial advance prices manually and could raise the starting rate for busier nights. For Costa, the company is already improving its food offer, and will roll out its Costa Collect (digital preorder) concept across London later this year, both areas which we believe could drive material like-for-like gains.”
 
Better Costa Coffee trading: “The company said that Costa UK has had a good start to the financial year, with a stronger run rate than quarter four +0.7%. Management is happy with its previous 2-3% like-for-like guidance for FY17 (MSe +2.5%). Some of this improvement was the price increase taken during quarter four, some volume. Having experienced four consecutive quarters of slowing LfLs, this should come as some relief, albeit it is early in the year.”
 
Net capex likely to come down: “The company is considering a £100-150m sale and leaseback which will reduce net capex from circa £700m to £550-600m, and we believe a rolling sale and leaseback programme could be instigated after that if this is a success. Leases are likely to be a more expensive source of funding than Whitbread’s recent ten-year 3.4% bond, but such a transaction would crystallise the development gains the company creates when building new hotels (that shows up in neither the P&L nor BS) and prove its strong covenant to future landlords thus reducing operating lease costs.”
 
Is this the best hotel company in the world?! “Finally, as we analyse the KPIs for Premier Inn, we wonder whether it could be awarded this ultimate accolade. For which other hotel company enjoys any of the following, let alone all of them? An occupancy rate exceeding 80%, a direct distribution mix of 93% (86% digital direct), an average Tripadvisor score of 4.5 across the portfolo, 7% annual unit expansion, and substantial real estate backing (it owns two-thirds of its hotels). Its main weakness is that it is perhaps too well run, offering limited like-for-like upside.”
 
What Rollo did not like:
 
Hotel trading remains tough: “The company described the UK hotel market as flat in the last six weeks, as we can see in the weekly STR data. The weak performance is not a surprise, but still the market data is disappointing. We think this is partly due to the Paris terrorist attack which had an immediate impact on London demand (with a smaller impact post Brussels), partly higher supply growth in London (circa 4% vs 1% in the regions), tough comparables, and Brexit uncertainty. These are hopefully largely temporary factors. The regions have also slowed to around zero revpar growth in the last eight weeks. Whitbread still expects circa 2.6% market revpar for FY17, or 1.5% for Premier Inn net of a favourable London mix and adverse extensions impact, and as it stands today this looks a little optimistic. However, we will have a clearer indication through May and June, which are more important months, don’t have calendar disparities, and have much easier comps. We assume +1.5% revpar in FY17 and every 1% is circa £8m or 1% to Ebit. Note that regional UK average daily room rates are 11% below prior peaks in real terms, and regional supply growth is still low at 1-1.5% (the regions being 80% of PI’s revenue), so as long as real GDP continues to exceed supply, revpar should continue to grow.”
 
Shrinking customer feedback lead over the competition: “Premier Inn’s value for money measure on YouGov’s brand index suggests it is at a record high of 33, but its hotel and coffee competitors are narrowing the gap. Similarly, Costa’s ‘UK favourite’ YouGov preference score has dropped from 39% to 36%, though the lead to Starbucks (13%) is as high as ever, suggesting perhaps artisanals are taking share. Both these competitors were struggling a few years back, and both have enjoyed improving and superior like-for-likes to Whitbread, but we note that both have also been pushing up their prices rather than discounting to claw back share.”
 
Opex spend rising: “After additional opex of £10m in FY15 and £15m in FY16, the company guided to another £15m in FY17, meaning a £40m recurring annual spend on technology and refurbishments, not immaterial on £550m of profit before tax. However, note this figure was already announced, and will be part funded by the efficiency gains discussed above.”
 
Capex levels still high: “Whitbread plans to spend another circa £700m on capex this year, not far from its Ebitda and by far the highest level of relative spending in our coverage universe. Around £445m of this will be expansion, mostly in hotels (including freehold assets in London and Germany, which could be recycled using S&LBs as above), and £255m on maintenance, mainly in hotels and restaurants (£185m). This is a high level, both relative to D&A (group circa. £200m, hotels £140m), and at 10% of sales is well above the 4-6% considered standard in the economy hotel segment. Premier Inn is in the middle of a major refurbishment programme in which it is converting 14,000 older ‘ID1/2’ rooms to the ‘ID3’ and ‘ID4’ format. This will move it more upmarket to compete against more midmarket players and generate higher room rates, but while customer feedback has been improving, this does not appear to have translated into a room rate increase.”
 
Hotel expansion light this year: “Although the new chief executive was confident with the 85,000 2020 hotel room target, the company reduced its previous guidance for FY17 room openings from circa 5,000 to 4,000-4,500. It opened 2,300 rooms in February alone, but such a large figure led to some disruption and customer dissatisfaction, so the company will move some openings into FY18 instead of chasing an annual target. We estimate it needs to open 4,000-5,000 new rooms a year to hit this target (depending on whether it is fiscal or calendar 2020).”
 
Group ROCE fell from 15.7% to 15.3%: “However, this was all due to £380m of unopened hotel properties on the balance sheet (£160m in the prior year), and adjusting for this ROCE rose from 16.5% to 16.9% (a fair adjustment we think, given this real estate will generate a return at some point). Hotels and restaurants’ underlying ROCE rose from 14.2% to 14.4%, and Costa from 46.3% to 49.9%.”
 
Still some questions over international: “Although we think it likely that Whitbread will exit Premier Inn in India and south east Asia, its German hotel business is subscale and could possibly require an acquisition, and Costa’s equity markets are still loss-making (France still under review, and China will be refocused from 30 to 15 cities). We therefore still don’t see International moving the dial at Whitbread.”


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