Usually, I don’t dip into the FTSE250 looking for purchase opportunities but with the usual dividend growth stocks trading at high valuations (See MCD and JNJ for just two examples) I felt the need to search elsewhere for some value.
Last week, I analysed Britvic PLC, and my dividend discount model showed that the company was potentially 10% undervalued, well today it’s time to take a look at another FTSE250 stock – Greggs Plc.
One thing that really stuck with me from reading Jason Feiber blog in my early investing days was the need to understand what a business does. Well, with Greggs it really doesn’t come much easier to understand. Greggs sells pastries, and Brits love pasties. In recent years Greggs has also diversified its business from a traditional bakery to a food-on-the-go retailer that offers anything from a pasty to pasta, there is even talk about the company branching out into stocking Sushi! Greggs has also moved swiftly with consumer trends by introducing ‘Balanced choice’ products which contain around 400 calories.
Greggs is present on most UK high-streets and has also been successfully expanding into motorway service stations. Overall Greggs now has around 1,700 stores with plans to expand to 2,000.
With it’s share price down 13% year to date, and nearly 20% since January, is now the time to buy?
At nearly 19 times earnings the stock appears expensive, and taking look at its historical p/e ratio we can immediately see that the stock has traded at far lower multiples in the past. It traded for 12.5 p/e in 2010 and 11.4 p/e in 2011. but by 2014 the stock has skyrocketed to multiples of 19.9 and in 2015 the stock was trading hands for a ridiculous 23.5 times earnings, namely due to lower EPS.
I absolutely hate paying above fair valuation for any stock, so why on earth is Greggs in my portfolio?
Why buy at a relatively high multiple?
In 2013 Greggs appointed a new CEO who embarked on an ambitious shift in strategy in order to aggressively target a growing food-on-the-go market. The company quickly shifted the format of their stores by focusing on a new bakery food-on-the-go format that has proven to be very popular with consumers. The company also quickly re-launched its improved blend coffee range in 2014. That coffee ended up being its fastest growing product.
Greggs is now uniquely placed in the food-on-the-go market with its ability to offer hot or cold products and fresh coffee for a competitive price. This really sets the company apart from competitors such as supermarket chains due to the freshness of the offering and from high-end competitors such as coffee shops by its pricing. The shift in strategy has evidently paid off with EPS growth of 42% between 2013-2014 and further EPS growth of 29% from 2014-2015. Whilst we don’t have a mystic ball to predict future growth we can be confident in the company’s plan moving forward in an industry that’s growing 9% annually.
Minimum wage advantage
In addition to this, Greggs has a step up on its competition in relation to costs. With chains such as Costa announcing that they will have to raise prices in order to pay staff the new £7.20 minimum wage, Greggs already paid staff £7.11 an hour meaning that they can maintain prices.
Greggs currently has a dividend yield of 2.72% which isn’t bad, but nothing to get excited about. But what really does excite me is the company’s commitment to grow the dividend. The company managed to grow its dividend by 30% from 2014 to 2015 with a juicy special dividend of 20p per share.
There’s no doubt that Greggs struggled before its turnaround but it was still committed to annual dividend increases and even increased its dividend during the financial crisis of 2008. It has now increased is dividend every year since 1999, bar a freeze between 2013-2014 where it maintained its payout in order to fund the turnaround.
With a payout ratio of 52% there is also still room for maneuver to increase the ratio should sales somehow disappoint.
What about fair value?
It’s really hard to find a fair value for Greggs simply because we don’t know if the turnaround will continue to deliver such outstanding EPS growth. It’s currently 2 years into its 5-year turnaround plan and I don’t know a psychic in order to help me predict the future. But, what I do know is that the first two years have been successful and management seem worth their wages from what I’ve seen so far.
I’m not going to put a figure on this stock but am happy in owning its dividend factory at an ok yield with a steady dividend growth history.
Dividend growth investors look at companies that have a history of annually increasing their dividend and Greggs has certainly proven its ability to do so. With a successful turnaround in full flow and an enviable position in a growing market I can see no reason why Greggs can’t continue to pay me dividends. This stock won’t be a core holding in my portfolio and I’ll be closely monitoring its turnaround progress. Should its success continue and EPS continue to grow I’m looking forward to some nice dividend paydays!