Greggs PLC: Undervalued, but how good is the business?
The pinnacle of British food
Hey everyone,
over the last year people frequently pitched me Greggs PLC as an interesting idea and asked me why I’m not invested in this company. Shares of the company fell 50% and are trading at levels last seen in the 2022 bear market, while valuation has derated to lows even below the C19 crash. Let’s examine this previous UK Fintwit favorite and see how high the quality of the business really is using my quality score.
My Mercado Libre Quality Score post showcases how a full breakdown looks like.
Check out this post if you want more details about the quality score.
Let’s dive in!
A short introduction to the company
Greggs was founded over eights years ago as a food delivery services for fresh eggs and yeast in Newcastle. 10 years later the first Greggs store opened and since then thousands more followed throughout the UK.
Greggs has become part of British culture with its iconic sausage rolls and other quick, convenient and cheap food. Through a combination of company owned and franchises locations Greggs has come to dominate the UK and enjoys customer loyalty for its fresh food, good service and cheap prices. A sausage role costs just £1.25 for 331 calories, making it good value for a quick snack or lunch.
Greggs is expanding and has to deal with many risks like a saturated market, tough UK macro, cannibalizing its own stores and general inflation. While the business sounds very boring and mundane, the rapid expansion over the last decades, its cash generation and position within the UK market make it a high quality company in the eyes of many investors. But what do I think? Let’s find out!
Optionality/Innovation (2/3)
While it doesn’t make sense to grow into adjacent industries, Greggs has been an innovator in its industry, recently launching a smaller sized store concept called Bitesize Greggs for high traffic areas with constrained space, cooperation with Tesco markets or its pioneering into vegan alternatives in 2019.
I do not think that they have much optionality to expand outside of the UK, because British food does have a certain reputation in Europe. It would probably be tough to recreate the economics and enthusiasm of the brand, so I’ll stay at 2 points.
Cash Conversion (3/3)
Greggs does produce a lot of cash and historically has converted a good chunk of it into free cash flows. The sharp decline, all the way to negative levels, does explain partially why shares have fallen so much. Operating cash flows have stayed much more stable, because Greggs currently is in an investment phase modernizing its infrastructure and IT which is expected to have peaked in 2025. I am confident that cash conversion will return to its historical levels, where FCF exceeds net income.
Management Alignment (3/5)
Greggs does have 5% insider ownership and active buying from management teams, but the compensation structure is nothing extraordinary. Decent, so I’ll give 3 points.
Secular Trends (2/4)
There isn’t much secular growth to benefit Greggs. There is some tailwind for convenience, but on the other hand the UK is going through some tough times. I can’t give more than 2/4 points here.
Margins (2/5)
Margins are rather stable over the long term without much operating leverage showing. C19 disrupted the business massively of course, but they managed to keep margins at decent levels of -1% for net income and FCF. Following the reopening margins expanded massively to peak at 16.5% EBITDA and have since declined to 13.3% as inflation and growth investments ate into (pun intended) profits.
I’m debating giving them three points, because the margins should improve as investment role over and franchising becomes a bigger part of the mix (~500/2000 locations at the moment).
Balance Sheet (2/3)
Greggs has a decent balance sheet with £451 million in debt, which is mostly (£360m) leases. Cash is very well managed at just £32 million and generally stays pretty low. This leaves the company at 1.2x net debt/EBITDA if you count the leases. In context of the massive reinvestment right now I’d be fine with higher cash, but they do have a revolving credit facility of £100m to draw upon if needed.
Let’s go deeper
In the next part I talk about the remaining 9 metrics, going over the competitive advantage, growth, reinvestment, predictability and valuation of Greggs PLC. Consider subscribing to Heavy Moat Investments and take your investment research to the next level.
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