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Chandan Dubey
Chandan Dubey
Articles (150) 

Better know a company: Greggs PLC

May 03, 2013 | About:
:Greggs is the UK’s leading bakery retailer specialising in freshly made bakery food. With over 1,671 shops across the UK served by ten regional bakeries, our 20,000 employees are proud to serve six million customers each week. - Annual Report 2012.
History: Greggs was founded as a bakery in 1939 and opened its first shop in 1951. After the death of the founder, his son Ian and his brother Colin took over. They expanded soon afterwards and bought bakeries such as Rutherglen in 1972, Thurstons in 1974, Broomfields, Price’s, Tooks etc in 1976. It started expanding outside UK by opening stores in Belgium in 2003, but failed to gain traction. They closed all these shops in 2008 and instead concentrated on the home front. They rebranded all their stores with a common Greggs brand so that they will benefit from a nationwide campaign. In 2012, the company began selling frozen pasties through food stores in Iceland. The company’s CEO at the moment is Roger Whiteside who held this title since Jan. 2013.

Greggs has been paying increasing dividends for the last 28 years [source: fool.co.uk].

The Bull Case:
Greggs has a very easy to understand business. It has good brand recognition in the UK and has performed very well, even during the financial crisis post 2008. Let us look at some key figures of the company.


We see a growing business with very stable margins. We also see that the company pays nearly half of its income on dividends and has sometimes used the extra cash to buy back shares. The book value has doubled during the last decade and the company has achieved nearly 20% return on invested capital with no long term debt.


This says loads about the company, the business and its management. We quickly realize that the business is stable, the financial situation is exemplary and the management is able and shareholder friendly.


Let us now turn our attention to valuing the business. Given that the company pays dividend of £0.2, the question is: How much should the yield for such a business be ? I would venture that 4% is a very good yield to get for owning such a business. This puts the price at £5 a share (NOTE: This is a very superficial analysis. If you continue reading the article you will be surprised as to a clear cut investment like this may not look that great after an hour or so of research and some critical thinking. But this will come later. For now let us continue our little enterprise here). Let us look at the price chart of the company.


We predicted the market sentiment quite well with our valuation. The stock has been trading in the £5 range since the last year or so (even before). The drop in the price at the end of the graph i.e., now needs a closer inspection. Following is the chart for just the last year.


The price drop is explained by the outlook section of the Interim Management Statement of Greggs:


We do not expect a significant improvement in the difficult underlying market conditions in the short term. The business is focused on continuing with our plans to invest in core sales performance whilst taking action to reduce costs. Although we are only four months into the year, based on current own shop like-for-like performance we believe that profits for the year are likely to be slightly below the lower end of the range of market expectations. We believe that analysts’ expectations for the financial year ending 28 December 2013 are in the range of £47.5 million to £55.2 million.
The stock has already dropped from a high of £5.23 to £3.99 - at which it is trading now. The question is - Should we go ahead and buy a business with 5% yield, no long term debt, net cash of £15.38mn and a fantastic track record of near 20% RoIC with shareholder friendly management?


A Closer Inspection: Following is the cash flow data from Greggs Plc from the last 10 years.


The company bought back most of the shares during 2006, 2007 and 2008. During this time the stock was trading in the range £3.56-£5.23. Observing the price graph, we may assume an average buy price of around £4.5 a share. This gives us a total of £85.5mn on share buybacks. The cumulative value of FCF, Dividend and Buyback has been shown in the table below.

(in £mn)2003-2012

Given that the company has not used debt, it did not need to pay a lot in interest expense. The FCF has gone into either funding the dividend or buying back shares. The company has spent £1 on buyback for every £1.65 on dividends.

A troubling development, in the meantime, is the fact that FCF has gone down over the years while the dividend has gone up. So much so that the trendline for the dividend has decidedly gone above the trendline of the FCF. What is not obvious from the graph below is that the total dividend paid is 1.8 times the free cash flow (for 2012). A situation like this is not likely to go for long - unless one of these three things happen: i) taking on debt to fund the dividend, ii) increasing operating cash flow, or iii) reducing capital expenditure.


i) Taking on additional debt is the most viable option in my opinion. Given that lack of debt was one of the most important attractions of Greggs as an investment case, I decidedly reject such an option as a basis for investment. Furthermore, given that the management has been loathe to any debt, this will be a “never before” situation for them - questioning such a move.

ii) Increasing operating cash flow is a good idea - if such a possibility exists. The 10 year revenue growth has gone from 13.23% in 2003 to only 4.9% in 2012. Greggs has tried to counter the decline by opening stores in different formats compared to its old high street bakery format. They now offer “food on the go” located away from the high street, “Greggs moments” in a coffee shop format, “Wholesale” by offering dedicated Ice cabinets in over 750 food stores across UK/abroad, and the recently planned 30 stores in Moto Service Areas. At least in 2013, this is not going to help. The company came out [BBC] and said that the sales have been down 4.4% so far this year. It blamed bad weather i.e., less opportunities to go out and “under pressure” consumers for the downfall. Given that Greggs already has twice the number of Starbucks and 200 more shops than McDonald’s in the UK (source [BBC]) - I doubt that opening new stores is a solution.

iii) Decreasing CapEx is the most reasonable idea which will also keep the investment thesis intact. The problem here is that the management already seems to be moving on with ii) and has planned to increase the CapEx instead.

Another fact I want to point out is that the capital expenditure has been quite close to the depreciation for Greggs - for a while.

In a situation like this, a dividend cut is the most probable outcome - if the sales continue to suffer in the short term.

Risks: Dividend cut is a very likely risk. Given that our superficial valuation rested on the track record of growing dividends - a cut will destroy our £5 fair value. On an FCF basis the company is very expensive. It has cash of £19.4mn and pension liabilities of £4mn. At £4 a share, the market cap is £404mn and the EV is £388mn. At £11mn in FCF the EV/FCF ratio stands at 35 ! Far from being cheap, this is an expensive price to pay for any business.

Like McDonald’s the company does not really sell healthy food. The health conscious crowd will probably not be a customer. Starting in 2003, Greggs opened 10 stores in Brussels as a “controlled, low cost, experiment”. This was seen as a launchpad for opening the business in France, Germany and rest of the Europe. By 2008 the company realized that it was unable to gain traction in the Belgian market, closing the stores at £3.5mn “exceptional loss”. The failure could be due to several reasons including not developing the brand, not giving it enough time, pricing, and any number of differences between Belgium and UK. The main outcome is that Greggs will not venture outside UK for the near future.

At first glance, the business does not seem cyclical. But the management report that I quoted above seems to disagree. Lack of consumer spending and seasonal changes can affect the business. I guess customers might think Greggs’ products as a “treat” and hence would cut down on it if they are suffering financially. Similarly, the business of Greggs is predicated on customers going out of their houses in large numbers. Good weather definitely helps the business.

Another significant risk is the possibility of increasing raw material prices. Greggs will have trouble passing these on to the customers. This will either decrease margins or decrease the revenue.

Additional Disclosure: I do not hold any shares. I got the idea from BBC while browsing their business section. The data/news has been taken from BBC, ft.com, and morningstar.com.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 4.1/5 (20 votes)


Vgm - 4 years ago    Report SPAM
CD -- thanks. I had also begun to look at Greggs after the recent earnngs warning and share price drop. A couple of observations and questions:

1. They have real estate worth some £110M which is around 25% of market cap. Did you factor this in?

2. Might borrowing lost-cost debt for share buy-backs be value accretive for shareholders? Many companies, particularly in the US, are doing exactly this.

3. Seems to me that their strategy to penetrate the European markets was misguided. Countries like Belgium and France have a highly sophisticated bakery/patisserie culture of their own.

4. You mention that Greggs, like McDonald's, will not attract the health-conscious consumer. I don't see that as a negative necessarily. MCD has done well, to say the least.

5. In the UK, I wonder if the big supermarkets Tesco, Sainsbury, Waitrose, etc, are literally eating the high street specialty bakers' lunch. The selection and value for money at the majors is likely appealing for cash-strapped shoppers, and convenient too.

Thanks again.
Cdubey - 4 years ago    Report SPAM
Thank you for the comment. Seems you have dug deeper in your analysis. I kind of stopped after finding that the stock has a large distance to fall before it will become fairly valued - if the dividend was not safe.

I did not factor in the £110 mn real estate. That was sloppy research. It does not effect the overall conclusion though. The company is still quite expensive £400 mn - on an FCF basis even taking out the value of the real estate.

I will answer point (2) in a separate comment.

In my opinion there will be a shift towards eating healthier food - at least in the coming generation. McD has done quite well and probably Greggs will do well too. It is yet to be seen if this shift will have major effect on sales. I for one will never eat at McD. My wife does sometimes ... but I am weaning her away from the practice.

You might be correct about the supermarkets eating away the business. But I don't think that is something I will worry about. There is enough room for both of them to survive. Furthermore, this is not a new development. Greggs has opened new ventures i.e., coffee stores and "food to go". They will figure out a way to milk the opportunities. It is correct that for the time being the customers will look for cheaper ways to shop and this is hurting Greggs.
Cdubey - 4 years ago    Report SPAM
Also, it is worth pointing out that I found exactly the same reasons not to invest in McD when it way trading around $85 a few months back i.e., customer shift towards healthier options and me not being a customer. But after the price has ran off I see it as a "safe" dividend stock. The tricks our mind plays with us !

What I want to say is that the risks are more pronounced when the stock is going down and they seem to melt away when it is going up. At some point you have to decide that the margin of safety is enough for you to start a position. I don't see Greggs at that point yet.
Cdubey - 4 years ago    Report SPAM
Assuming no growth in FCF and 2% inflation, if the company takes £40 mn in debt at 3% coupon payable at the end of 10 years then the FCF in the two cases (with debt and without debt) will be as follows.

FCF (no debt) £11mn for eternity

FCF (debt) £9.8mn for 9 years, -£29 mn in year 10 and then £11mn for eternity

The lower FCF for the first 9 years is because of £40*0.03 = £1.2mn in interest expense. In year 10, the company will pay back the £40 mn in debt, incurring a negative FCF of £29mn.

The value of the discounted free cash flow at 2% inflation = £561 mn (no debt)

The value of the discounted FCF at 2% inflation = £518 mn (with debt)

If the company used the debt to buy back shares then at £4 a piece it will be able to buy back 10 mn shares, decreasing the share outstanding to 91 mn (from 101 mn in case of no debt).

Shareholder value of FCF with no debt = £ 561 mn / 101 mn = £5.554

Shareholder value of FCF with debt = £518 mn / 91 mn = £5.69

So yes, the debt will be accretive to shareholder value. By the way, I just came up with this analysis - so there is large chance of making mistakes in the reasoning. The calculations on the other hand are correct and have been rechecked.
Vgm - 4 years ago    Report SPAM
Thanks for the full responses.

For me, and probably for you too, the critical argument against is the low FCF. For a prospective investment I like to see FCF yield around 10% and then some reasonable prospects for growth on top. Greggs seems not to have either.
Cdubey - 4 years ago    Report SPAM
@Vgm: That is precisely correct. I would be happy with no growth for a while too ... if the FCF yield was 10%.
Batbeer2 premium member - 4 years ago
Hi guys,

Interesting stock, thanks!

FCF is at 10m or so but capex is at 50m.

50m is roughly 20% of PP&E (gurufocus 10y numbers.) That's a lot!

People don't ordinarily spend 20% of the value of their car or house or shop on annual maintenance. High capex usually means they have some growth expense elsewhere in the business too (staff training, advertising etc).

It may be worthwile to check out the per-store profit of older shops and try to estimate precisely how much they have been spending on the new ones. If you assume the new shops perform as well as the older ones in a couple of years, that may give you an idea of what management is trying to accomplish.

A bit more pessimistically, you could assume they simply stop investing for growth at some point and all the new stores earn nothing. What is the profitability of the core business? At first glance I wouldn't be surprised if the core business (old shops) alone are able to generate 50m - 70m of owner earnings.

I may spend some time on this one. If I find something, I'll let you know.

Vgm - 4 years ago    Report SPAM
Batbeer -- thanks for your comments. Yes, do let us know if you find something relevant.

In the meantime I'd be interested in your process: when you look at a business like this and see the low and deteriorating FCF yield that CD noted, is it a walk-away or are there other parameters which you believe could still make it a decent investment to investigate? If so, which would those be? Could combined FCF + dividend be used as a surrogate for low FCF?
Batbeer2 premium member - 4 years ago
I always look at FCF but most businesses can't and shouldn't be valued that way.

A company that has significant reserves of natgas (or for that matter iron ore or aggregates) but chooses to do precisely nothing until a nearby resource is exhausted. Under some circumstances, that's probably the most profitable strategy.


A company that is spending every single penny it earns investing for growth. Car-Mart is a recent example I looked at. They are opening new dealerships at a double digit rate. That eats a lot of cash. Meanwhile, it is clear that dealerships that have been in operation for more than 2 years are very profitable....


Farmland that is left unused for a couple of years. The land may be worth more after that.


A conglomerate (WPO, BRK). The cash they earn on one end, they invest elsewhere. FCF becomes meaningless.

In short, it is a rare business that can be reasonably valued based on FCF.

Maybe SIAL, KO, SPLS.....

For a business that doesn't return cash to shareholders, I think the rate of growth of book value may be a bit more useful.

For Greggs, book value per share has been growing. While the stock trades at a premium to book, it is also clear they are depreciating their assets at 10% or so. With this type of business, I would expect their core assets to be long-lived. That is why I think it is worth looking into.

I want to know how long current management has been at the helm and if they still own stores from the nineties. If so, how are those stores performing? What is their book value?

There just may be a surprise. Usually not, but it is worth checking out. Every once in a while you'll find something 99% of investors have been ignoring.... bingo!

As a practical example, take Ryanair. I wrote about that one a while ago. They were investing huge amounts. Now they've taken a breather and true earnings are beginning to shine through as FCF.

The depreciation they were charging for their planes made no sense (it still doesn't). You could verify this by looking at the prices they were fetching for their used planes. The planes last for 30 years yet PP&E is being depreciated at 10% or so. In fact, they usually sell their used planes for more than they paid when new! They only buy them when Boeing has no customers. That way they get a ±50% discount. They sell them when Boeing has a long waiting list.

I'm not saying Greggs PLC is the same but the pattern is similar. In the case of Ryanair, it was worth checking out.
Cdubey - 4 years ago    Report SPAM
@Batbeer2: Thanks for the interest.

That was my first guess too. They have been opening a lot of stores. For example - they opened 100 new stores in 2012 itself. They spent £14 mn on new land and buildings. The rest is not clear i.e., for remodeling the stores to make them operate. But definitely this £14mn can be added to FCF if they stop opening new stores.

With a new FCF of £25mn and £110 mn in real estate - the company will be worth £360 mn at 10xFCF. Still a 10% drop from current prices.

At current prices the question boils down to this: is the dividend safe ? The answer in my opinion is that unless they don't take on debt, reduce cap-ex or grow sales - it will be cut. IF the dividend is cut, the downside is quite real. I will buy it if the price drops 30% from the current value. Then it gives me a good margin of safety.

Please update when you have things to say about the company. I am very interested.

Vgm - 4 years ago    Report SPAM
Batbeer -- great to get your thoughts. Thanks.

Taking the other side of the argument, it could reasonably be claimed that there's no guarantee that a company which does not have real FCF, but only prospective FCF, has risk associated with it. For example, the natgas reserves may not materialize, or the fast growing company may not reach full potential, or the turnaround may be unsuccessful. There's a gamble on the future.

In the case of conglomerates, it's possible, though time-consuming, to analyze the constituent parts. Europe has many such holding companies, and value investors do analyze the parts. Buffett stresses the importance of "owner earnings" which is a particularly 'pure' form of FCF.

I'm very influenced by Glenn Greenberg. At a talk at Columbia a couple of years ago, he was asked how he addressed valuation - what metrics he used, etc. He replied that his metric was FCF. Obviously FCF is not a standalone, and needs to be supplemented by a solid understanding of the business, but he went on to show how he thought about Google in FCF terms and how it was (at the time) cheap when FCF and expected growth were taken together with cash balance. In fact, he stated specifically that he looks for companies which have around 10% FCF and which are growing at least at 3-5%, to give a projected yield of 13-15%. It's the minimum he accepts.

So, I guess my view is that companies with a history of solid FCF (let's say 10%) are a good starting point for further DD. It may, as you point out, rule out certain types of investment - but that's ok.
Batbeer2 premium member - 4 years ago

If memory serves, Greenberg is the guy who wrote about Ryanair in the last edition of Security Analysis.... and he sold Ryanair just before they turned off the Capex and the stock took off :o)

Yes, there's risk if there is no steady FCF. I would argue that the risk is no less for a company that does have steady FCF.

Yes, KO is a great company that has steady FCF. Then again, you have GNI with fan-tas-tic FCF, ROE, gross margin... At 5x earnings, I believe it is also one of the dumbest investments out there. Don't get me started on WHX.

Sometimes, FCF is a good measure of owner earnings. KO, SIAL, PMD come to mind. All I'm saying is that these are exceptions. For the likes of Solitron, Ryanair, CRR, CRMT, USG, BBRY and VPRT, (a Greenberg stock) FCF as reported under GAAP is a terrible proxy for run-rate owner eanrings.
Vgm - 4 years ago    Report SPAM
Thanks Batbeer.

However, Greenberg has one of the very best records out there.

I agree on GAAP. We sometimes need to dig deeper to uncover true economic earnings.
Batbeer2 premium member - 4 years ago
Yeah... don't get me wrong I'm a fan of Greenberg!

More often than not I find it too tough to understand his investments though.

I always take a long hard look but I'm often unable to quantify the value (ONE, VPRT).

Ryanair was one of the few Greenberg picks of which I could get an idea of the value.

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