The share price of Costa Coffee owner Whitbread (LSE: WTB) rose by more than 15% on Friday morning after the company said it would sell the coffee chain to Coca-Cola for £3.9bn.
Whitbread, which also owns Premier Inn, was already working on plans to spin out the coffee business into a separate listed company.
Today I’ll explain why the Coca-Cola deal is better than expected and should be seen as a good result. I’ll also reveal whether my previous buy rating for Whitbread stock remains in force.
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A great-tasting deal
Coca-Cola didn’t have a hot drinks brand until today. Now that it does, the soft drinks giant expects to be able to create “opportunities to grow the Costa brand worldwide”. This seems realistic enough to me — the US firm’s global marketing and distribution system has few rivals in terms of scale and sophistication.
The price being paid by Coke reflects its big ambitions for coffee — the headline value of £3.9bn is 16.4 times Costa’s earnings before interest, tax, depreciation and amortisation (EBITDA) last year.
That’s a pretty full valuation, in my view. In comparison, US coffee giant Starbucks currently trades on a multiple of 10.4 times EBITDA.
Whitbread says that cash proceeds from the deal are expected to be around £3.8bn. The firm plans to return “a significant majority” of this to shareholders, after using some cash to reduce debt and top up its pension scheme.
Based on this guidance, I’d expect a shareholder return of at least £2.5bn, possibly more. I suspect a large part of this will be in the form of share buybacks, as these will offset the loss of Costa’s earnings. Coffee profits accounted for about one quarter of Whitbread’s group earnings last year.
What’s left of Whitbread?
The Costa sale is expected to take 12-24 months to complete. After this, Whitbread’s remaining business will be the Premier Inn hotel chain. During the year to 1 March, this popular brand generated sales of £2bn and a pre-tax profit of £498m.
Whitbread’s balance sheet also showed £3.2bn of land and buildings as of March 2018. I’d guess that the vast majority of this belongs to the Premier Inn business, providing attractive asset backing for the shares.
Should you buy, sell or hold?
At the time of writing, Whitbread’s share price is 4,675p. That’s an increase of about 25% compared to one year ago.
If my assumptions about share buybacks are correct, then I estimate Whitbread shares trade on about 17 times 2019/20 forecast earnings at the moment, with an expected yield of 2.4%.
That’s not a bargain, but it may be worth considering. Pre-tax profit at Premier Inn rose by 8.8% to £498m last year. This budget hotel business generated an underlying operating margin of 24.5%, and a 13.4% return on capital. These are very strong metrics, in my opinion.
If this rate of growth can be maintained, then my view is that Whitbread shares are probably still worth buying.
