Bed down with this well-run growth stock
2nd February 2023
Smart pricing, solid brand equity and confident expansion plans mean Whitbread’s growth narrative looks assured
The hotel sector has been through three challenging years. First came the pandemic’s closed doors, disruption and plunging sales, then followed cost inflation, labour shortages and margin pressures. Now, near-term demand must reckon with weak consumer confidence. No wonder hotel numbers are shrinking; the latest report from market research group CGA and consultancy AlixPartners found that the number of UK sites fell by 3 per cent between December 2021 and 2022. Independent operators fared the worst, with a 10 per cent contraction at “accommodation-led venues” over the period.
But this downturn in property numbers has played neatly into the hands of Whitbread (WTB). The Premier Inn hotel owner and UK market leader pointed to “the decline in commercial supply” in its January trading update as a trend that is supporting its “strong” pricing. While the independent hotel sector estate contracts, Whitbread is expanding. In October, the chain operator raised its long-term target in the UK and Ireland to 125,000 rooms, up from 110,000 previously. The current estate is around 82,700 rooms.
Over 95 per cent of Whitbread’s revenues were generated by its UK operations in its half-year to August. But the company is also expanding briskly in the German hotel market – having added more rooms than any other hotel chain in the country since 2019 – and is bullish on the potential for significant growth. Whitbread is targeting a return on capital of 10 to 14 per cent in Germany, having invested £1bn of capital in the country to date, and management expects to hit break-even on an adjusted pre-tax profit basis in 2024.
Management cites a raft of good reasons for faith in the country. Not only is the German market large and well-supported by strong patterns of domestic short-stay travel, but it remains highly fragmented and without an established leader. Independent operators represent a “large proportion of the market”, but as in the UK, this segment continues to decline. How German expansion will pan out remains to be seen, but the latest signs are positive, with 45 hotels now open and a further 36 in the pipeline.
When it comes to pricing, Premier Inn’s model looks well-suited to the current economic environment. With downtrading evident across a range of sectors – from grocery to beverages – the relatively cheap rooms it offers could prove enticing to individuals travelling for pleasure, business or necessity. The average room rate (ARR) at Premier Inn in the third quarter was £75 in the UK and £77 in Germany – low prices compared with those at many competitors. However, with recession bearing down on both countries, a demand hit can’t be discounted.
As well as attractive pricing, Premier Inn can boast strong brand equity, and has won numerous industry awards for brand power over the years. Its marketing and pull are certainly effective – as represented by its market share gains in recent years.
The operating model has also proved flexible in a way that is enhancing revenue per available room (revpar), as evidenced by the company’s launch of a booking portal for business customers, and an increase in the number of premium rooms on offer.
There is a margin benefit to these investments, too. To Panmure Gordon analyst Lena Thakkar, such initiatives amount to “a more automated yet tailored pricing model allowing the company to optimise yield and profitability from customers looking for different things, such as the flexibility to cancel, stay in a higher quality room or cater for business needs”.
Growing – and maintaining – a hotel estate doesn’t come cheap, mind, meaning Whitbread’s room expansion plans mean big spending. The company has guided for capital expenditure in the current financial year to come in at between £500mn and £550mn, after a £300mn outlay in the first half. The good news is that this is backed up by a solid balance sheet.
A key point here is that around half of the total estate is freehold, with a 55 per cent weighting in the UK. This stands out against many listed peers, and – in the company’s words – offers “protection from increasing property costs and therefore lower earnings volatility during economic downturns”. While some expansion-minded investors take a dimmer view of this asset-heavy model, we think it looks handy as 2023 shapes up to be another difficult year in macroeconomic terms. Regardless, the estate mix gives Whitbread options should its priorities and capital allocation plans change in the coming years.
Still, the liquidity position looks reassuring. As of 1 December, Whitbread’s cash pile stood at £284mn, and the company signed a new £775mn five-year revolving credit facility last May. The resources are there, both for expansion and the return of excess capital.
Returning capital to shareholders is a key strategic priority. Numis analysts expect the full-year results in April to confirm a return of up to £800mn, while HSBC analysts believe an update on capital allocation could augur a share price boost.
Current trading and costs
The market liked what it saw in Whitbread’s third-quarter update last month. The shares were marked up after the company revealed solid revenue growth against the pre-pandemic baseline for the three months to 1 December. Like-for-like sales were up by 15 per cent, with accommodation sales rising by 27 per cent. Year-to-date revpar grew by a quarter, while UK accommodation sales outperformed the market by 26 percentage points.
But while accommodation sales boomed, food and beverage performance continued to struggle. Sales were down 6 per cent on the 2020 financial year, and the company doesn’t expect these to hit pre-pandemic levels any time soon. As for the wider ‘value’ pub market, the situation remains challenging in terms of both custom and costs.
These aren’t the only overhead issues facing Whitbread and its peers. For the next financial year, management expects 7 to 8 per cent cost inflation on its £1.6bn cost base. Higher labour costs – with the national minimum wage increase in April still to come – have combined with inflationary pressures in energy and food and beverage to heap pressure on margins.
But management is doing what it can, which amounts to a lot. Cost savings of £40mn were achieved in the year to March 2022, and £100mn-worth of extra belt-tightening is planned over by 2025. Three-quarters of utility costs have been hedged, and efficiencies, pricing and growth are all helping matters, leading analysts to expect an operating profit margin of 20.5 per cent for the 12 months to the start of March, which is a fairly solid result given the cost context.
An attractive valuation
Like many domestic-focused UK stocks, Whitbread’s shares have been on the way up over the past six months. After an unsurprising collapse in value during the pandemic, they are making up ground despite the challenging trading environment.
The valuation had de-rated earlier in 2022, reflecting fears about the recessionary climate, risk, earnings yields and the impact on hotel demand. Despite the recent rally the shares still trade on 21 times consensus forwards earnings – well below the five-year average of 38 times. This looks like an attractive entry point for a company whose net profits are forecast to grow 26 per cent over the next three years.
Profit growth isn’t the only way to value the business, though. HSBC analysts raised their target price from 3,800p to 4,100p following last month’s update, noting Whitbread’s large property holdings. “Valuing that on a 5.2 per cent yield largely supports the share price by itself,” they wrote, arguing that “the operating business is included for free”. Deutsche Bank concurs, suggesting the book value “is not even reflected in the actual market capitalisation”.
There are, of course, many ways to skin a cat. However you go about it, Whitbread’s strong recent trading, attractive market position and growth possibilities collectively mean the shares offer real potential.
Original article here: https://www.investorschronicle.co.uk/ideas/2023/02/02/bed-down-with-this-well-run-growth-stock/
Author: Christopher Akers, Investors’ Chronicle
Director, Research Analyst, Consumer & Leisure