Greggs’ interim results highlighted that the consumer is responding well to the company’s transition to a leading food-on-the-go retailer. This has led to record revenue growth and a step change in gross margin, as well as enabling further investment to fund future growth initiatives, while funding a special dividend as expected. Our forecasts are broadly unchanged following four upgrades in six months.
Greggs has delivered strong interim results with record revenue growth, which has led to a good improvement in the operating margin, driven by mostly sustainable gross margin improvements and good control of other operating costs. H119 likefor-like (LFL) revenue growth was 10.5%, the gross margin improved by 230bp, and the clean operating margin improved from 5.4% in H118 to 8.0% in H119. These produced y-o-y growth of 57% in clean PBT and 59% in clean EPS.
The interims benefited from growth across all product categories as footfall and transactions increase in response to Greggs’ marketing initiatives and new product launches. Ongoing space growth, extended opening hours, new product launches and further trials of initiatives such as click and collect should help sustain this trend.
Our forecasts for FY19 and FY20 are broadly unchanged, which reflects assumptions for higher LFL growth in FY19, some modest gross margin pressure in H219 and a lower tax rate (20.4% from 21.0%). We raise our LFL assumption for FY19 to 7.9% from 7.3% given the performance in H1 and the ‘strong’ current trading indicated in the outlook statement. We factor in a 30bp deterioration in gross margin in H219, versus our previous estimate, given increasing commodity price inflation, which is solely due to pork prices given the swine flu epidemic in China. We make no significant changes to our FY20 assumptions beyond the flow through and annualisation of the H219 gross margin reduction and lower tax rate.
Our DCF-based valuation has reduced modestly from 2,059p to 2,028p given the change in timing of corporate tax cash outflows (see page 4). Our forecasts continue to assume revenue growth beyond FY21 of 6%, cautiously fading to 2%, and a perpetuity EBITDA margin of 16% (FY21e 15%). Greggs is highly cash generative as evidenced by the special dividend announced with the H119 results.