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Thu 26th Apr 2018 - Update: Rollo on Whitbread, Domino's results
Jamie Rollo – no quick caffeine fix for Whitbread, ten questions: Morgan Stanley leisure analyst Jamie Rollo has said Whitbread investors need to believe in more than a demerger of Costa Coffee to make an outsized return. Issuing an ‘Equal-weight’ rating with a target price of 4,200p, Rollo said: “Whitbread’s plan to demerge Costa Coffee is commendable we think, even though we always thought it was likely. The focus yesterday (Wednesday, 25 April) was on the timing of the split, which the company said could take up to 24 months (though pursued as fast as practical), but which activist shareholder Elliott said should be achieved within six months. We think Whitbread gave a reasonably solid defence of its longer timetable, which includes completing a series of complex IT and business system upgrades that depend on group shared resources, delivering the efficiency programme at a time of high inflation and increasing product innovation, and (likely simpler) negotiations with pension trustees, bondholders and landlords. We would add time gives optionality for an operational turnaround and/or to take part in industry consolidation. While we think the company probably could achieve the demerger faster than two years, given the shares are trading in-line with our sum-of-the-parts valuation, and visibility is low on the complexity of the company’s internal systems and efficiency plans, we do not see much upside from pushing for a very rapid separation. We were admittedly surprised Whitbread’s shares did not perform better after the announcement (they ended down 0.2%), not least as it could ignite Costa takeover speculation. However, the shares were already up 15% from their recent lows, and the demerger rumour was speculated in the weekend papers. More fundamentally, Whitbread already trades at our £42 sum-of-the-parts. This values Costa at £2.5bn (post trimming our forecasts) based on 9.5 times Feb-20e Ebitda (in the middle of Greggs and Starbucks) and equivalent to 19 times price-to-earnings ratio (assuming it is demerged debt-free). We think this is generous enough given it is seeing weak like-for-like and margins. We value Premier Inn & Restaurants at £7.4bn (including all plc central costs), based on ten times Feb-20e Ebitda (in-line with the European hotel average) and equivalent to 16 times price-to-earnings ratio (assuming it takes all the debt and pension). We think this is conservative for what we think is probably the world’s best-listed hotel company (taking its leading metrics for occupancy, TripAdvisor score, online travel agencies mix, unit growth, and freehold mix), but revpar is negative, and the UK outlook is weak. Our bull case on Costa is £3.4bn, which uses a sum-of-the-parts valuing UK equity at nine times, UK/international franchise at 12 to 14 times, machines at 12 times, and China at £0.3bn (currently loss-making). While this is 36% above our base case, it would only add 12% to the Whitbread share price. Hence, we think shareholders would need to see either a takeover of Costa, or a more aggressive multiple on hotels (perhaps with a property disposal), neither of which are fundamental reasons to own the stock (and neither of which the activists seem to be demanding). While the FY18 results were in-line with our expectations, the company reported its weakest fourth-quarter like-for-like sales figure since the 2009 crisis, with hotel revpar -1.5% and Costa UK equity store like-for-likes -1.8% (-2.5% on its previous definition). This makes us worry how weak revenues could get in the next downturn if they are negative now, at a time of high employment and solid GDP growth, and the company may not have much cost cushion left given the significant £250m efficiency plan. Some of this like-for-like weakness is due to the internal cannibalisation of the business (the company quotes a 1.4% impact from new capacity in the 25% of catchments seeing capacity growth, implying -4% revpar here versus +1.7% in unaffected catchments), and it was encouraging to see return on capital increase, and the company beat its margin targets. Still, the like-for-like sales deterioration in the second half is concerning, and we doubt the first-quarter results will provide much relief given the impact of the bad weather on trading in March, a tough environment in London, and relatively tough comparables in each division. Our headline forecasts do not change for FY19, but we tweak the mix to downgrade Costa offset by an upgrade of hotels (all efficiencies), and nudge down earnings per share over FY20-21 by 1% to 2%. We set out some questions we think investors might like to ask management over the next few weeks.

1. Why could a demerger take up to 24 months? Can the company give more detail on the timing and quantum of the action it is taking on technology and efficiency to give a sense of when they will be complete? Is the company giving itself time to turn around the business, and/or take part in industry consolidation?

2. Would Whitbread consider selling Costa as an alternative? Has it received any interest? How would it evaluate offers, and how does it value Costa as a demerged entity?

3. How should we think about the allocation of debt, pension deficit, and plc costs between the businesses? Are there any friction costs such as additional central costs or tax?

4. What would management’s response be to additional activist demands such as operational improvements, or real estate disposals?

5. Why were fourth-quarter like-for-likes negative despite a robust economy? What does this imply for the company’s sales performance in the next downturn? Are there any further efficiency gains that could be gleaned?

6. How would the company respond to a downturn in the UK economy and/or a ‘hard’ Brexit? Might it consider slowing the pace of expansion in either hotels or coffee shops, given it is cannibalising itself? Would it consider buying back shares or increasing its dividend more if it stops expanding and free cash flow improves materially? 

7. Why did Costa’s like-for-like sales weaken to -2% in the fourth quarter despite the easier comparable and benefit from its food offer? The company saw encouraging growth in its new food lines, but high street footfall weakened, so can it break down like-for-likes between newer and mature stores, food and drink, high street versus other? What is management’s view on when like-for-like sales might turn positive?

8. What is the scope to expand Costa Express (machines) into other UK markets (eg corporate vending) and overseas? What are the economics of UK versus international machines? Why did the company pull out of Canada?

9. Why is Costa China still loss-making and when is it expected to break even? How confident is it in its target of 1,200 stores by 2020, given it missed its 2016 target of 500 and 2018 target of 700 (450 currently)? With £5m additional cost going in this year, and a changing mix to less profitable stores, how confident is it in its target for £20 to £25m Ebit from Costa International?

10. In hotels, how will the company cover its weighted average cost of capital on the recent £250m Foremost deal? We estimate Premier Inn generates roughly £3,000 Ebit/leased room in the UK, implying a less than 3% return on capital expenditure on the acquisitions roughly 3,000 leased rooms. How much capex does it need to invest at its target 10% return on capital expenditure in order to meet its weighted average cost of capital overall in Germany?”


Domino’s Pizza reports UK like-for-likes up 7%: Domino’s Pizza has reported UK like-for-like sales were up 7% for the 13 weeks to 1 April 2018 with system sales increasing 10.6%. The company opened nine stores in the UK during the quarter taking it to 1,054 outlets at the end of the period. It continues to expect to open 65 to 75 Uk stores during 2018. UK and Ireland system sales were up 10.4% to £285.5m. UK online sales were up 16.2% year-on-year, representing 78.9% of system sales in the first quarter. Total group system sales increased 18.3% to £311.1m. The company now has 1,203 stores group-wide. The company also reported improving system sales performances in international businesses. The Republic of Ireland delivered 5.2% year-on-year growth while Switzerland delivered 17.6% year-on-year. In Norway, like-for-like sales were up 10.3% and it is continuing its Dolly Dimple’s conversions with 33 Domino’s-branded outlets trading at the period end. In Germany it completed the acquisition of Hallo Pizza and the integration process has begun. Chief executive David Wild said: “The year has started well, with continued good growth in all of our markets. In the UK, customers are responding very positively to our clearer value proposition, with strong scores for value for money and overall satisfaction. We have also made excellent operational progress, with the rapid roll-out of GPS continuing. I am encouraged by our international operations, which are gaining scale as more customers grow to love our great tasting pizzas.”

John Vincent – casual dining ‘splurge’ is over: John Vincent, co-founder of natural fast food brand Leon, has argued the “splurge” of casual dining expansion is over. Vincent, who founded the company with Henry Dimbleby and Allegra McEvedy in 2004, said over-expansion has been halted as costs go up. He told City AM: “Casual dining is in a recovery ward. I think what’s happened is private equity piled in and thought it could just press a button, open lots of sites and sell it to the next private equity company – and that’s been a challenge.” Vincent said operators were now more cautious due to increased wages, rates, and currency pressures, and had realised they could not “just open bloody everywhere”. Food-to-go operators such as Leon, Pret a Manger and Itsu have gained market share in the past few years, even as casual dining operators struggle. Earlier this month, Leon revealed it is launching Thai fast food pop-up Tuk Shop – a joint venture with Bangkok-based food group Aylmer Aaharn. The restaurant will debut this spring in an existing Leon in Shaftesbury Avenue in London’s Soho.

Ten Entertainment Group owner and executives sell 15% stake: The owner and executive members of Ten Entertainment Group have sold a 15% stake in the tenpin bowling operator. Private equity firm Harwood Capital Harwood Capital has sold 8,921,834 ordinary shares of 1p each, chairman Nick Basing has sold 450,000 ordinary shares, chief executive Alan Hand has sold 217,037 ordinary shares and chief commercial officer Graham Blackwell, has sold 130,798 ordinary shares. Ten Entertainment Group stated: “In aggregate the sellers have sold 9,719,669 ordinary shares representing 15.0% of Ten Entertainment Group’s existing issued share capital, at a price of 240p per share. The placing was conducted through an accelerated bookbuild. Numis and Peel Hunt acted as joint bookrunners for the sellers in connection with the placing. The proceeds of the placing are payable in cash on usual settlement terms.”

Fuller’s to stage debut London Brewers’ Alliance Craft Beer Festival: London brewer and retailer Fuller’s will host the inaugural London Brewers’ Alliance Craft Beer Festival on Saturday, 23 June at its Griffin Brewery in Chiswick, west London. The festival will be attended by more than 40 of London’s best breweries. Each brewery will be pouring two lines of beer showcasing the depth and breadth of the London beer scene. John Keeling, Fuller’s global ambassador and chairman of the London Brewers Alliance, said: “Finally – a beer festival at Fuller’s. This is something I have wanted to see since my first day at the brewery – 30-something years ago. A bit like a good beer – these things should be done right and cannot be rushed. I am delighted the London Brewers Alliance wanted to work with us on this and I am looking forward to welcoming nearly all the London brewers to Fuller’s Brewery and tasting their beers. I am proud to be the chairman of the London Brewers Alliance. The enthusiasm of the members to work with all London breweries to improve quality, share information, and ultimately help each other make better beer, strikes a chord with me and I am eager to ensure London continues to grow its reputation as a hub and centre of amazing UK craft beer.”

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