A trio of leading analysts - Jamie Rollo at Morgan Stanley, Wyn Ellis at Numis and Karl Burns at Panmure Gordon - take a closer look at the Costa investor day.
Jamie Rollo at Morgan Stanley said: “Whitbread gave an upbeat presentation on Costa, but its guidance on unit economics, possible start-up losses in France, and reinvesting margin growth in central costs suggest consensus expectations may be ambitious. As we highlighted in our November 6 note, Priced For Perfection, we see Whitbread as a high quality investment, but think that it is now fairly, if not fully valued.
“The investor day again highlighted the strength of Costa, and the credibility of its growth plans. We value Costa at 16x EBITDA in F15, and think that this valuation (equivalent to 29x P/E) fairly reflects the strong attractions here. Long-term forecasts look a little stretched. Its unit profit bridge implies a £73-93m EBIT increase by F18, but central costs will take £10-20m from this, a roll-out in France perhaps another £5m, and China is now not expected to break-even for another couple of years (vs this year previously), suggesting £63-73m of EBIT growth from expansion.
“The Express machine economics and mix comments were also slightly disappointing. Our F18 EBIT estimate is £202m, a £112m uplift from the base of £90m in F13, and this needs c.£45m of LfL profit growth, a CAGR of c.8%.
“The company was clear that progress would not be linear due to lumpy investments, when we assume c£20m EBIT growth a year (in-line with the last 3 years and consensus). It looks like growth may slow (same rate of expansion on a larger base), and become a little more unpredictable.
“The presentation made it clear that Costa will not be demerged in the near-term, and if proving itself internationally is the prerequisite, a split could be many years away. Costa has been a fantastic success story and continues to grow rapidly, but we think this is fairly reflected in our valuation multiples of 16x EBITDA and 29x P/E in F15e.”
Wyn Ellis at Numis said: “We believe that there were two key questions to be answered at yesterday’s Costa Investor Day: (1) what scope is there for continued growth and roll-out in an increasingly saturated UK coffee market; and (2) is Costa any closer to establishing that the brand has legs for profitable growth outside the UK?
“The answer to the first question was resoundingly positive with continuing UK social and economic trends driving demand and the market far from saturated. As far as the answer to the second question is concerned, Costa continues to put the building blocks in place and, whilst there are a number of positive indicators, the jury remains out.
“In April 2011, Costa set out a target of doubling system sales to £1.3bn by 2016. In April 2013, it confirmed that it was on track to achieve this growth milestone and announced a new 2018 sales target of c.£2bn.
“As expected, no increase to targets yesterday, but there was the expected added granularity on how the targets will be achieved and on the financial metrics. These are useful for modelling purposes but we do not expect consensus forecasts changes. Costa is continuing to develop the brand and, if margins and LFLs start running ahead of expectations, it will re-invest to drive continued growth in customer satisfaction.
“There are now 1,711 Costa stores in the UK vs. 777 at Starbucks and 580 at Nero. This includes equity (owned) and franchised stores. Roughly 70% of profit is generated by the equity stores (av. contribution of £94k per unit vs. £83k in FY11). Equity stores are expected to represent 66%-75% of store additions.
“Costa Express has been a significant success story. There are now c.2,500 machines in garage forecourts and retail stores but other markets have been tough to crack. A new sleek machine is being trialled for offices, hospitals and education establishments and Costa is optimistic about the potential in the UK and overseas.
“Costa is now present in 30 countries with 625 franchise stores (projected to grow at 10% pa) and 437 JV/Equity stores. Management made clear that the growth path would not be linear and that development would take time, with continued investment in infrastructure. We remain positive about the long term potential but do not expect material profits in the short -to-medium term.”
Karl Burns at Panmure Gordon said: “The Costa coffee investor day revealed a business in good shape with c10,000 points of distribution (stores, machines and wholesale) and a UK retail business that has had 44 consecutive quarters of LFL sales growth. We estimate EBIT could increase from c £90m EBIT last year to at least c£170m in FY 2018E when system sales should have doubled to £2.0bn, of which international will be c1/3. c1,400 new Costa stores will open and c3,000 Costa Express machines will be installed.
“This is all very impressive but will require capital of c£365m and therefore the implied EBIT return of c22% will lag the current 35%. We are particularly cautious about opening another c550 UK stores and think it is too early to assess the likelihood of success in major European markets, such as France. The existing International footprint remains highly attractive but China is unlikely to be profitable for another couple of years.
“The investor day revealed a business in good shape with c10,000 points of distribution (stores, machines and wholesale) and a UK retail business that has had 44 consecutive quarters of LFL sales. Management has strength in depth and Chris Rogers, managing director, particularly impressed as he revealed a more charismatic leadership style. We estimate EBIT could increase from c £90m EBIT last year to at least c£170m in FY 2018E when system sales should have doubled to £2.0bn, of which international will be c1/3. c1,400 new Costa stores will open and c3,000 Costa Express machines will be installed. This is all very impressive but will require capital of c£365m and therefore the implied EBIT return of c22% will lag the current 35%.
“The UK equity retail business has had 44 consecutive quarters of LFL sales growth. Store economic are very impressive with a 25% EBITDA margin and a payback period of just over two years. However we are particularly cautious about opening another c550 UK stores.
“The group has a clear plan to get to profitability in China, return to profitability in Poland and make the existing franchises more profitable. Furthermore, the group plans to make deeper inroads into large developed markets such as France, Spain and Germany. By FY 2018E c1/3 of system sales will be from international stores.
“The company’s machines and Proud to Serve (wholesale) businesses have huge potential for further growth, albeit not hugely profitable. The second generation machine can offer 240 drinks which should increase penetration of education, health and business target markets.”
