The ravages of inflation on margins for retailers are unavoidable. For the low-cost bakery chain Greggs, higher costs for ingredients, packaging and energy, together with a bigger VAT bill and the reintroduction of business rates relief, flattened profits during the first half of the year.
That trend is expected to continue over the second half, with analysts forecasting pre-tax profits of £148 million, broadly in line with last year, but not the £108 million seen in 2019. For a company that had gained a reputation for racking-up high earnings growth over the past three years, stalled momentum makes a cheaper valuation understandable. But at the current price, there is reason to think that the shares could regain a higher rating from investors.
The other source of investor anxiety? The risk that inflation will worsen and that weaker consumer spending will hit sales, causing Greggs to miss the market’s earnings forecasts. Shares in Greggs, a FTSE 250 constituent, trade at 17 times forward earnings, down from a multiple of 40 at the start of last year.
Cut the earnings forecast by analysts for this year by 20 per cent and the shares still look inexpensive, priced below the five-year average profit multiple. Greggs assumes that cost inflation will run at 9 per cent for the company this year, peaking in the autumn. If inflation does ease, as economists at the Bank of England expect, and sales growth is robust, then a return to profit growth seems credible.
In the first six months of the year, underlying sales were 23 per cent higher than the same period last year. Easier pandemic comparators have flattered that figure — first-quarter sales were up 37 per cent and slowed to 11 per cent during the next three months.
Yet like-for-like sales have risen 13 per cent in the past four weeks. That includes the benefit of price increases that were implemented in May. The good news is increases have not turned off consumers.
Analysts at Investec raised the sales forecast for this year by 7 per cent to £1.44 billion — a 17 per cent increase on last year and implies a double-digit rate of growth for the second half. Adding delivery service from some stores is one catalyst for like-for-like sales growth and so is opening in some locations until 8pm.
Extending the sales avenues from existing shops may be one way to hit a target of doubling sales in the next five years. The other is expanding its shop estate. Greggs plans to open a net 150 outlets this year and believes there is room to grow the total number of shops to 3,000, from 2,239 — which are a mix of owner-managed and franchised shops.
Convenience is crucial for a retailer trying to lure in passing trade. The risk of an ambitious expansion strategy? That you cannibalise sales from nearby stores. Sturdy underlying sales in recent weeks are reassuring that this is not materialising. Greggs is in 5 per cent of airports and less than 10 per cent of retail parks around the country, Roisin Currie, the chief executive, estimates. These are two of the type of location that Greggs is targeting, along with rail stations and the Central London area.
Being highly cash generative means expansion plans are backed by a sturdy balance sheet. The group had net cash of £146 million at the end of June, and even after including lease liabilities, debt would equate to roughly half the adjusted earnings before tax and other charges forecast by analysts this year. Even after taking into account investing in opening shops, analysts believe that the group will manage a 14 per cent rise in the dividend to 64.86p a share, which would represent a yield of about 3 per cent at the current share price.
If sales remain on track, Greggs could regain its former glories.
ADVICE Buy
WHY A discounted valuation leaves room for the shares to recover over medium-term
Morgan Advanced Materials
Manufacturing specialist Morgan Advanced Materials is entering the economic downturn fighting fit. Robust demand from the semiconductor, healthcare and cleaning industries, plus the enduring benefit of pandemic-era cost-cutting, mean that trading figures for this year are expected to be at the top end of market expectations.
The FTSE 250 constituent makes high-performing ceramic and carbon materials for products used in industries from aerospace to renewable energy and healthcare. Over the first six months of the year, revenue rose 11 per cent on an organic basis and adjusted operating profit increased by 23 per cent thanks to its operational gearing.
Higher sales volumes helped boost the operating margin further within the 12.5 per cent to 15 per cent target range, at 13.7 per cent. With its specialised products going into hardware such as trains, planes and wind turbines, Morgan is in a good position to pass on the full impact of cost inflation by raising its prices.
The rump of the business typically tracks industrial gross domestic product, recording an average of 2.5 per cent to 4 per cent annual sales growth. Nearly half of its sales are in markets that could suffer from a slowdown in industrial demand, chief executive Pete Raby said.
But sales from four faster-growth markets — clean energy, semiconductors, clean transportation and healthcare — may prove more resilient. In normal times, the firm reckons those markets, accounting for 21 per cent of sales, can deliver high single-digit growth combined each year. Latent demand caused by a global shortage of semiconductors might provide one cushion for sales.
A forward price/earnings ratio of just over ten, at the bottom end of the stock’s long-running range, more than accounts for the risks associated with shakier industrial demand.
Morgan might mitigate lower sales volumes by easing expenditure on areas such as hiring, and putting the brakes on increasing manufacturing capacity. Brokerage Peel Hunt raised its profit forecast for this year to £139 million but left its forecast for next year at £141 million to account for macroeconomic challenges.
ADVICE Buy
WHY The shares look too cheap given exposure to more defensive markets
