Whitbread has used its Capital Markets Day to reiterate its belief in its “unique, vertically-integrated model” as a lever for growth and value creation.

The clear focus for the group is its Premier Inn brand and while its 700 restaurants remain a key part of the estate, chief executive Alison Brittain said the company would look to focus on brands such as Bar + Block and Beefeater while culling other underperforming concepts.

The update at the Capital Markets Day confirmed that £2.5bn would be returned to shareholders on the back of the Costa sale. Following its recent £500m share buyback programme, the company said it intends to intends to pursue a tender offer to repurchase up to a further £2bn of shares.

The group reiterated its view that it can grow Premier Inn from 74,000 rooms in the UK to 110,000 with a network potential of 170,000 including international ambitions.

On the back of the update, Morgan Stanley analyst Jamie Rollo wrote:

“Up to £2.5bn total cash return. Whitbread announced a tender offer of up to £2bn, which combined with the £0.5bn share buyback currently ongoing will take the total cash return to £2.5bn. This is a material 25% of its market cap, and the company said it would review any surplus capital after completion of the tender offer. The company aims to publish the documentation at its FY19 results on 30 April and complete it following a vote at the 19 June AGM. The company has at least £0.8bn headroom, given adjusted leverage of 2.4x on a May 2018 proforma basis is well below the 3.5x target (and the company said this could be stretched if the right M&A opportunities were to arise), so this should be sufficient to fund bolt-on deals.

Ambitious German target. As anticipated, Whitbread set an ambitious 60k room target for Germany, well above our 20k assumption, having already explained the merits of expanding here (highly fragmented with the largest brand having a 2% share vs the UK at 10%, low branded budget share of 8% vs UK at 27%, PI expertise in budget / domestic / corporate customers). The company has very limited presence here, and this target is equivalent to more than the largest budget players combined (ibis, Best Western, Motel One and B&B each have 10-20k rooms), and there was no time frame given, but this is clearly decades of growth. However, Premier Inn has ~6k rooms in its pipeline, getting it to the number 5 player in just 5 years, and it has significant headroom for M&A as discussed above. It plans to invest £200-300m a year, the same as the UK, which would fund 1-2k rooms organically as well as a small bolt-on deal. In terms of contribution, Germany is a lower return market than the UK (with Whitbread guiding to 10-14% vs 12-14% in the UK), is more of a leasehold market than the UK (so lower EBIT/room), and has less scale, so even getting it to say half the size of the UK it would be nearer to one-third of UK EBIT. While this would be a material contributor and improve Whitbread’s long-term growth prospects, short-term the bottom line figures will be weak, with the company guiding to a £12m loss in FY20, close to break even in FY21, a modest profit in FY22, FY23 getting to 4-5% of EBIT, and a decent return on the £700m of currently committed investment by FY24 (£70m would be 12% of EBIT). We model £(13)m, £(2)m, £19m, £30m over FY20-23, in itself a 10% EBIT boost for the group.

Cost savings. We were positively surprised with the revised cost saving target of £220m over 2020-22, of which £120m is opex. This represents c.£40m in annual savings, which compares to £50-55m in annual external cost headwinds, resulting in a net cost headwind of £10-15m. There was also the suggestion that there may be more good news to come as the £10m in costs associated with the Costa dis-synergies will reverse and there may be further central cost savings, once the Transitionary Services Agreement comes to an end.

Property ownership defended, higher estate valuation. In the first defence of an asset-heavy strategy we can recall, Whitbread did a good job explaining how its globally unique and vertically integrated model enables it to maintain end-to-end control of the properties, and ensure consistency across the product, key for budget hotel guests. It believes that segregation of ownership across the value chain results in a ‘leakage’ of value via inconsistent priorities and competing interests, and this can be seen in inconsistent estate quality at its leasehold peers (where landlords may not have invested fully), weak expansion at its asset light peers (Whitbread has expanded at 3x the growth rate of numbers 2-4 combined over the last 3 years), and OTA’s dominance over the distribution at most of its competitors. The company is flexible regarding property ownership / leasing, but prefers ownership given the security of tenure, asset appreciation, higher margins, ability to churn, control over the product, and cheaper funding, relative to leasing. The company has revalued its estate from £4.1-5.2bn 3 years ago to £4.9-5.8bn today, on slightly different rental yield and coverage ratios. It plans to do a revaluation every two years, which is encouraging. Taking the EV of £7bn net of the cash return, and deducting the real estate value, implies £1-2bn for the opco, and a 5% rental yield implies 2-3x EBITDA for this.

Solid UK prospects. The company did a good job quantifying the strength of its business model and its market-leading KPIs on occupancy (80%), direct distribution mix (97%), TripAdvisor (ranked no.4 of all hotel brands globally) and returns (a steady ~13.5% for an asset heavy model over the last 5 years despite a 9% capital employed CAGR, cost headwinds, and weakening RevPAR). On a value for money basis, PI seems to be gaining ground, ranking ahead of Airbnb as well as its branded competitors, and management said they will look to place even more focus on value for money going forward. The company also emphasised the quality of the RevPAR it generates, which ought to be viewed on a net basis (taking account of commissions paid) rather than gross when comparing with competitors. Effectively PI has structurally lower distribution costs than peers. F&B on-site continues to be fundamental to the hotel offering, with 25% guests saying they would not stay in the hotel without a good breakfast offering. The dynamic pricing strategy can be optimised further to minimise “spoil” (rooms priced too high, left unsold) and “spill” (rooms sell out before the date-of-stay). Expansion of Premier Inn UK is expected to slow as the company is only looking to grow the network from 74k rooms currently to 110k rooms in the medium term, slowing from 4-5k per annum to 3-4k. However, this could be revised higher depending on the success of the roll-out of ZIP (£20 super budget offer) and hub (now looking to expand outside London / Edinburgh).”