Greggs — Showing us how it’s done

The Next Generation Greggs programme, initially launched in January 2020 and then accelerated in October 2021, is expected to accelerate Greggs’ long-held strategic objective of becoming the customer favourite for food-on-the-go (FOTG). The programme has four drivers of growth, supported by higher investment in the supply chain and systems: (1) accelerate the rate of estate growth and improve the estate’s quality; (2) new digital channels (delivery and click and collect (C&C)) to enable Greggs to extend reach and customer choice; (3) grow sales in the evening with the help of menu enhancements and leveraging all distribution channels; and (4) broadening customer appeal and driving loyalty, with higher customer engagement and the Greggs Rewards loyalty scheme.

The goal of the five-year programme was set at an ‘ambitious’ doubling of sales to £2.4bn from FY22–26. By the end of FY23, the second full year of its five-year growth plan, Greggs had added roughly half of the incremental revenue that was expected by FY26, therefore it is clear the company is making good progress towards the FY26 target, albeit helped by elevated selling price inflation. Our new FY26 forecasts show that we expect Greggs to exceed the FY26 target, with 10–11% annual growth in each of the next three years. We forecast slightly lower growth in operating profit, a CAGR of c 10% as lower-margin delivery sales and customer use of the app both grow in importance. Greggs enters its peak years of capital investment with a strong balance sheet, net cash excluding leases of c £195m and net debt including leases of c £124m. We forecast a reduction in the gross cash balance in FY24 and FY25 before it rebuilds in FY26.

Over the long term Greggs has enjoyed a re-rating as its focus on taking market share in the FOTG market helped to deliver greater revenue growth and levels of profitability. The prospective EV/sales multiples of 1.4x for FY24 down to 1.1x in FY26 are at the middle and low end of its more recent historical average multiples, a range of 1.1–1.6x since FY15, when the benefits of the FOTG strategy began to show through in higher levels of profitability that are more consistent with current and expected levels of profitability. The prospective P/E multiples for FY24 of 21.9x and 18.4x in FY26 are towards the middle/upper end of recent average multiples, which have ranged between 16.5x and 23.0x since FY15, excluding the distortions from the COVID-19 pandemic. These valuation multiples are supportive of our updated DCF-based valuation of £30.20.

We see the main sensitivities as:

Greggs was founded as a Tyneside bakery in 1939 and grew to become a national chain with c 1,670 stores by the end of 2012. From 2013, management’s strategic vision has been to become the customer favourite for FOTG, with a value-based offer.

The four pillars of the long-term strategic vision have been consistent since then:

Prior to the COVID-19 pandemic, from FY13–19 management’s strategy generated strong financial growth with CAGRs for number of stores of 3%, revenue of 7%, gross profit of 9% and operating profit of 19%. Greggs’ revenue has rebounded strongly from the outbreak of the pandemic, surpassing FY19’s revenues in FY21 (lower transactions with compound price inflation) and the benefits from the five-year growth plan (see below) are evident in the financial performance through FY23.

The long-term strategic vision remains the same, but in January 2020 management launched the Next Generation Greggs programme, with the aim of increasing customer loyalty and choice, and widening distribution of Greggs’ products across multiple channels and more dayparts. Following the initial disruption caused by COVID-19 in Q120, management decided to accelerate the programme as the pandemic had accelerated the expected change in customer behaviour. At the October 2021 capital markets day (CMD), management quantified how it expects Next Generation would drive growth, setting an ‘ambitious’ five-year (to FY26) target to double revenue to c £2.4bn, with four key growth drivers:

All of the above will be enabled by higher investment in the supply chain and systems to support the expected growth and new services, and are underpinned by the Greggs Pledge (ongoing improvement in its ESG credentials and continuing to act responsibly).

Leaving aside the post COVID-19 recovery to prior trading levels, we consider in the sections below the key drivers to revenue growth.

While management provided a revenue target for FY26, there was no guidance for expected profitability. It hoped to maintain existing levels of profitability from natural cost leverage leading to underlying margin expansion (subject to the unpredictable nature of input cost inflation), which has to support an indicated 0.5–1.0 margin point pa for incremental investment in sustainability. Before the pandemic, Greggs enjoyed a gradual increase in operating margin from 5.4% in FY13 to 10.3% in FY19, but was more typically 8–10% before the FY19 peak.

Beyond its UK aspirations, management has highlighted the potential to seek growth internationally or by acquiring another brand, potentially after 2024, the peak year of its capital investment plan.

In the video below, chief financial officer Richard Hutton gives an update on the progress made in FY23.

At the 2021 CMD, management estimated estate growth (ie space growth and like-for-like growth from company-managed and franchise stores) would contribute half of the expected incremental revenue growth through FY26.

Prior to this, Greggs typically opened 90–100 net new stores pa, but the 2021 plan accelerated this to 150 net new stores pa. The regular growth profile of the new store additions suggests the anticipated incremental revenue should be relatively linear, subject to relative store sizes, the maturity profile of new stores and the intra-year phasing.

The opportunity to scale more quickly is due to a number of contributing factors:

Within the 2021 target of 150 net new stores pa, 100 were expected to be company-managed stores and 50 would be franchises, and there would be 50 relocations a year of company-managed stores. For FY24 management targets 50 relocations and 195 refurbishments.

The company is making good progress on the plan, adding 147 and 145 net new stores in the first two full years of the plan (ie FY22 and FY23), and management has indicated 140–160 net new stores will be added in FY24. There is typically a skewing to net new store openings in the second half of each financial year, so the contribution to the year’s results will be relatively limited.

Greggs does not disclose details of area traded in its stores, but we believe the average store size is likely to increase through the plan, which will, in part, be required to support the growth from newer channels (see below), as well as the provision of seating in more stores. These are reflected in greater reported growth from new space than the average number of stores.

The higher rate of store expansion leads to the obvious question of whether management is over-extending, as happened in the wider restaurant space pre-pandemic. Here, management points to the belief that shop density is currently lower than it could be, the greatest opportunities are outside traditional towns and suburban locations where it is well-represented already, and even in the ‘top postcode’ Greggs continues to open new shops. With respect to shop density, management’s assumption of one store to 20,000 people to reach the target of at least 3,000 stores compares with the current density of one to 30,000 people, and versus the current top postcode of one to 15,000.

The aspiration to grow sales from more channels (ie delivery and C&C to complement traditional walk-in) and sales in more dayparts (ie the under-penetrated evening in addition to traditional day time) should drive sales densities for the stores and improve store-level contribution given relatively limited marginal operating costs.

In aggregate, at the 2021 CMD management targeted incremental sales from FY22–26 of £280m (c 23% of the total growth target) from a combination of growing evening and delivery.

Following successful trials that began before the pandemic with Deliveroo, Uber Eats and Just Eat, management decided to roll-out the delivery service via an exclusive partnership with Just Eat. In July 2020 the plan was extended with a view to providing nationwide coverage of major cities from 600 stores by the end of FY20. Following a further successful trial, Greggs ended its platform exclusivity with Just Eat and began working with a second delivery partner, Uber Eats, in Q323.

The move to delivery reflected the increasing importance of delivery to how people consume food with increased convenience provided by the expansion of companies such as Just Eat. Management believes the motive for using delivery has evolved/is evolving from being mainly based on a lack of desire to cook to it being considered an affordable and regular treat, and therefore a more attractive growth prospect.

The availability of Greggs’ delivery service has evolved quickly, increasing to 1,000 stores by the end of FY21 and in 1,440 shops by the time of the FY23 results, of which 1,340 stores were accessible via Just Eat and 930 stores via Uber Eats. Post the pandemic, delivery’s share of company-managed stores has naturally reduced from 8–10% of company-managed store sales to 5.6% in FY23, the majority of which is generated in the daytime. At c £90m of revenue in FY23, following c 24% y-o-y growth, it contributed just over 1% of Greggs’ total revenue growth in the year. At the October 2021 CMD, management targeted an incremental £180m of delivery revenue during the five-year plan, so it is making reasonable progress against the target.

Sales through the delivery channel have a higher average transaction value, roughly three times the size of the walk-in average transaction value of c £4 given the order is typically for more than one person. The gross margin for delivery is lower than average given the aggregator’s platform fee, partially mitigated through premium pricing on products, and Greggs benefits further down the income statement from leveraging the fixed store operating costs. Removing the exclusivity with Just Eat meant a higher fee to the platform and to Uber Eats, and therefore a reduced gross margin on delivery sales, which management expects to be compensated for by higher aggregate volumes.

Greggs’ C&C service, available on the website and app, allows customers to order in advance and choose where and when to collect the order from a dedicated in-store collection point. It was rolled out to all company-managed stores from September 2020. The consumer benefits from an easier and better shopping experience, with more time to browse the menu and collection from a dedicated collection point reducing the need to queue, a greater guarantee of availability of food, as well as more opportunity to personalise the order given the greater time between order and collection.

The post 4pm dinner market, at an estimated c 38% (source: Greggs CMD 2021 presentation) of the total FOTG market (which simplistically excludes supermarket food bought and prepared at home, and full-service restaurant/pub food) makes it the largest daypart. Due to Greggs’ historical product offer and focus on primarily the lunch and, more latterly, breakfast markets, its share of the FOTG evening daypart was estimated to be 1.6% in 2023, a good increase from the prior year’s 1.2%. It remains well below its share of the breakfast market of 9.9%, lunch 6.8% and snacks 5.1% in 2019, as highlighted at the CMD, and therefore represents a significant source of future growth.

Total evening sales represented 8.7% of Greggs’ company-managed store sales in FY23, and we estimate that evening sales accounted for £130–140m revenue in FY23, the majority of which was from walk-in customers. The evening was the fastest growing daypart for Greggs in FY23, as it was in FY22. At the time of the CMD in FY21, management targeted incremental revenue from evening walk-in customers of £110m, and £70m from evening delivery, albeit recognising the difficulties of estimating the split by channel. We conclude therefore that Greggs has made better progress on developing the walk-in revenue than evening delivery revenue.

The recent growth in market share reflects the significant increase in the number of stores trading beyond 4pm and the required enhancements to the menu to attract those customers.

By the end of FY23, Greggs had extended the opening hours of 1,200 stores until 7pm or beyond. Greggs began experimenting with extending its trading hours to the evening in the autumn of 2019, following some initial development of the menu to offer items more suited to the evening, for example pizzas, and investment in hot food cabinets. The initial trials, before Greggs had a delivery channel, indicated, as might be expected, that evening trading may not be appropriate for all locations but was successful in high footfall locations such as city centres and travel hubs. With delivery in place management believes more locations become viable in the evening, not just those with high footfall.

While products such as pizza slices and chicken goujons have proved to be popular, to drive growth the menu has been enhanced (eg more sides and chicken options), and customisation has begun, initially with pizzas and baguettes. In FY24 new trials will include customisable hot chicken wraps and made-to-order drinks.

Improving customer loyalty is seen as a key opportunity in making further market share gains, with a ‘difficult to gauge’ estimate, per management, that improved CRM had the potential generate c 12% of the incremental revenue growth over the five-year growth plan. Management believes that a combination of raising awareness and improved messaging and targeting will drive a combination of increasing frequency of purchase and spend per visit.

Unlike many of its competitors, Greggs does not significantly invest in above-the-line advertising, given the view that direct sight (ie in-store advertising and promotion), word of mouth and social media channels are more cost-effective and efficient.

Central to its ambitions is the Rewards loyalty scheme (originally launched in 2014) and the revamped Greggs App, which enables Greggs to engage with customers more frequently. The app has proven to be very popular with customers, no doubt due to the discounts available. In 2023 12.5% of the transactions in company-managed stores involved scanning the app, a significant increase from 6.2% in FY22.

Supporting the above growth drivers is ongoing investment in the supply chain and technology. The move away from a traditional bakery, with in-store bakeries, to focus on the FOTG market with significantly more stores has necessitated a dramatic change in the central supply network and store infrastructure. Three/five-year investment plans that began in 2013 and 2016 gradually changed the infrastructure and capacity so that it could support ‘substantially beyond 2,000’ stores.

In the current five-year plan, there is further investment in the supply chain, including additional production lines, a second automated freezer and more distribution capacity. Recent work begun/commissioned includes: an additional pizza line in Enfield in FY22 that tripled its capacity. A fourth savoury production line close to the company’s head office has been commissioned, and the redevelopment of two regional distribution centres will be completed in FY24, the latter adding enough capacity to support 300 more shops. With the FY23 results, management confirmed the locations for two new facilities. The first, to be opened 2026, will provide manufacturing, storage, automated picking and distribution for frozen products including new savoury and sweet production facilities. The second, to be opened in 2027, is a new national distribution centre for ambient and chilled goods. Both are significantly larger than its radial sites, the new national distribution centre provides logistics capacity to 700 shops.

In addition to the investment in infrastructure above, which has constituted the bulk of capex, Greggs has invested in technology and processes to free staff time to devote to customer service, improve food availability as well as drive efficiencies. Greggs began the roll-out of SAP in 2015, and the deployment across the supply chain was completed in FY22. Management believes the core IT infrastructure is well invested, therefore the focus of technology spend will be on digital engagement with customers, as well as ongoing investment in making operations more efficient and systems upgrades.

The overall expected capital investment programme to support the aspiration to double revenue by FY26 was quantified at the time of the CMD in October 2021 at c £890m from FY22–26. The new guidance for capital investment of £250–280m in FY24, £225m in FY25 and £175m in FY26 will take the cumulative investment over the five-year period to £976m, if we use the middle of the guided range for FY24. The higher spend reflects the bringing forward of spend on one of the sites by a year, plus inflation on raw materials, a knock-on effect of Russia’s invasion of Ukraine.

Greggs has purposefully extended and improved the quality of its product range to tailor it to the demands of the FOTG customer and market, offering a more varied menu across the differing dayparts, while retaining its strong heritage in bakery, which has been successful in driving sales growth. The product offer is differentiated from many competitors by the way it is freshly prepared in the shop with the aim of delivering an ‘Always Fresh, Always Tasty’ experience. The aim of new product launches is to provide customers with new reasons to visit Greggs. With respect to pricing, outstanding value for money is a key attribute of the offer, meaning Greggs will not aim to match the lowest prices across all competing products but will aim to be highly competitive against rivals.

Key developments in the evolution of the past and future product offer have included:

Chief executive: Roisin Currie. Roisin became CEO in May 2022, with previous roles as people director, retail director and property director. Roisin has been a member of the operating board since 2010 and has played a key role in the development of the recent strategic plans. She has been with Greggs since 2010, following 19 years as retail people director at Asda Wal-Mart.

Chief financial officer: Richard Hutton. Richard qualified as a chartered accountant with KPMG and gained career experience with Procter & Gamble before joining Greggs in 1998. He was appointed CFO of Greggs in May 2006. He is also a non-executive director of The Lakes Distillery Company and a director of Business in the Community.

We see the main sensitivities as:

Greggs enjoyed a better FY23 than we originally anticipated, which is impressive given the challenges elsewhere on the high street. It highlights the appeal of the product offer and the success Greggs is having with its new initiatives. We increased our estimates at the time of the H123 results based on strong top-line growth and management’s guidance for lower underlying cost inflation than originally anticipated.

At the start of FY23 we forecast a strong year of growth for Greggs: revenue to increase by 13% yo-y to c £1,711m and 9% growth for both operating profit (to c £169m) and PBT (to c £161m). Following a more difficult FY22, when profit growth was limited due to escalating input cost inflation despite strong relative growth, we anticipated better relative profit growth versus revenue growth in FY23, which came through in the numbers. Reported revenue of c £1,810m surpassed our initial estimate by 6%, operating profit of c £172m by 2% and PBT of c £168m by c 4%.

The table below shows the summary income statement for Greggs with our updated estimates for FY24 and FY25 and our new estimates for FY26, the final year of the five-year investment plan. It is clear that Greggs is making good progress on its five-year plan. FY23 reported revenue of c £1,810m is almost exactly halfway to the original five-year target of almost doubling revenue to £2.4bn by FY26, after only the second full financial year. Achieving the target has no doubt been helped by the unexpected high inflation that persisted in FY22 and FY23.

FY23 year-on-year revenue growth of 19.6% included 13.7% like-for-like growth on company-managed stores. The year was helped by the flow through of price increases made in May, October and December 2022 and price rises made in June 2023. The latter price rise and one made at the end of December 2023 will flow through into FY24’s like-for-like revenue growth. The net addition of 145 stores to a total of 2,473 by the period end was equivalent to just over 6% growth from the numbers of stores at the end of FY22.

The reported gross margin for FY23 of 60.8% versus FY22’s 62.0% was below our estimate from the start of the year of 61.7%. The lower margin reflected a combination of food cost inflation exceeding Greggs’ own selling price inflation, increased customer participation with the app and the growth of delivery, which has a lower gross margin than company own sales due to the fees to the delivery platform companies. There was also a one-off step change to gross margin on delivery sales from higher fees to the delivery platforms as Greggs moved from its exclusive relationship with Just Eat in Q323.

Greggs aims to recover overall cost inflation at the operating profit level, however the differing levels of inflation for individual costs will, naturally, affect the individual line items in different ways. The gross margin, above, was negatively affected by higher relative cost inflation in cost of goods than selling prices increased. Conversely, operating costs below gross margin had lower relative cost inflation and declined relative to revenue in FY23.In particular, distribution and selling costs benefited from cost inflation being lower than selling price inflation and despite investment in store staff costs for evening trading and additional marketing. Underlying cost inflation was 8.5% in 2023, with greater cost inflation of 11% in H123 than H223’s 6%. Management has guided to 4–5% underlying cost inflation in FY24, mainly driven by 9.5% overall inflation in its largest cost item, wages and salaries, which compounds the 8% experienced in FY23. Food and packaging (33% of the cost base) inflation are expected to be broadly neutral, while energy costs (4% of the cost base) are expected to be marginally deflationary.

Greggs’ overall corporate tax burden has increased with the rise in the standard corporation tax rate to 25% from 19% from 1 April 2023. Going forward management anticipates its effective tax rate will increase to 1% above the headline rate due to expenditure for which no tax relief is available (eg depreciation of properties acquired before the introduction of structures and buildings tax allowances) and acquisition costs relating to new shops.

Prior to the COVID-19 pandemic, Greggs’ improved profitability fed through to higher free cash flow generation in absolute terms and, more importantly, relative to revenue. Post the outbreak of the pandemic, free cash flow generation has been a little more variable as profitability has decreased marginally, as explained above, and the capex programme to support the five-year growth plan has gradually increased.

Management has been clear that FY24 will be the peak year for capital investment in the five-year plan. The guided spend for £250–280m in FY24 followed by c £225m in FY25 and c £175m in FY26 and the phasing of the spend has changed a little from the guidance this time last year of £220m, £200m and £190m, respectively. Prior to the pandemic, gross investment in tangibles and intangibles averaged just over 7% of revenue, which includes expansionary capex.

Greggs finished FY23 with a better gross cash position (c £193m) than we had anticipated (£172m), mainly due to the insurance proceeds received. This enabled management to declare a special dividend of 40p/share at a cost of c £41m, a very welcome surprise as management had previously indicated special dividends were unlikely while it goes through the peak of capital investment. Shareholders have been well-rewarded with ordinary dividends (progressive dividend policy with dividend cover of 2x by diluted earnings) and special dividends, which have become frequent in recent years (ie in FY15, FY19, FY21 and FY23).

Greggs has no debt apart from operating leases, which totalled c £320m at the end of FY23, but it has a £100m revolving credit facility (RCF) that runs until December 2025, which was undrawn at the end of FY23. Management intends to refinance the RCF in the year ahead.

Greggs generates a very attractive pre-tax return on capital employed that has typically been above 20% since FY19, excluding 2020, which was negatively affected by the initial outbreak of the COVID pandemic. The increase in the asset base over the next few years during the peak investment cycle is expected to lead to a dilution in the return, back towards a still very respectable 20%.

The main changes to our estimates for key figures in FY24 and FY25 are shown in Exhibit 7.

Our operating profit estimates for FY24 and FY25 are relatively unchanged but we reduce our PBT estimates by 2–3% respectively to take account of both lower interest income on cash balances given the unexpected special dividend payment and higher capital investment guidance from management. In addition, one of the new supply chain facilities will be funded with a new operating lease, which also increases interest payable from FY25.

Our revenue estimates have increased to reflect a better contribution from new and larger stores, which is consistent with the trends of recent years. Our revenue estimate for FY26 surpasses management’s five-year target of £2.4bn, which is logical given the extra help provided by higher-than-expected selling price inflation in the last two financial years. The forecast CAGR for revenue growth of 10–11% includes 5–6% new space growth each year.

We have trimmed our gross margin estimates for FY24 and FY25 by 30bp to reflect the benefit of better relative selling price inflation versus cost inflation, a reversal of FY23, offset by some dilution from more sales via the app and growing delivery revenue across two platforms with the previously mentioned less favourable commission rates on those platforms.

We primarily value Greggs using a DCF-based valuation and look at its prospective multiples, growth estimates and profitability versus a relatively imperfect group of quoted peers, and relative to its own historical valuation multiples.

Our 10-year DCF valuation yields a fair value of £30.20/share (£29.70/share previously). Beyond our explicit forecast period, the calculation assumes annual revenue growth fades to 3% by our terminal year, FY33, and then terminal growth of 2%. After the indicated capital investment programme, we assume fixed capital investment of 5% of sales and working capital investment of 1% of sales. In addition, we include an imputed outflow for right-of-use assets of 3% of sales.

We use a cost of capital of 9.0% (10% previously) as we factor in both lower bond yields of 4.0% (4.5% previously) and equity risk premium of 5.5% (source: Damodaran, January 2024) (5.9% previously). The table below shows the sensitivity of our valuation to changes in the cost of capital and terminal growth rate assumptions.

Below we show how Greggs’ revenue growth, profitability and valuation compare with three set of peers: UK restaurants and pubs, UK restaurants and UK food retailers, all annualised to Greggs’ December year-end.

Our forecasts of low-double-digit revenue growth for Greggs in FY24 and FY25 compare favourably with the majority of the highlighted peers, while our estimated profitability (EBIT margin of 9.5% in FY24 and FY25) is higher than the medians for the separate UK-listed industry groups, but not the US-listed restaurants, many of which operate a franchise model. Greggs’ premium revenue growth and higher profitability versus the majority of the UK-based peers support higher EV/sales and P/E multiples. Greggs trades at a significant discount on both valuation measures relative to the US peers.

In the charts below we show Greggs’ prospective EV/sales and P/E multiples versus its historical high, average (number quoted) and low multiples since FY13, when the FOTG strategy was introduced.

In the first chart, our calculation of enterprise value (EV) excludes lease liabilities to enable an easy comparison across time, that is before FY19 when IFRS 16 was introduced. Therefore the EV/sales multiples will differ slightly to those in the previous section as these included IFRS 16 liabilities. The chart also shows Greggs’ operating margin for all years except FY20, when it reported an operating loss. In the second chart, we have excluded FY20 all together given the reported net loss.

We can see Greggs’ EV/sales multiple broadly trended up post FY13, as did its profitability. Trading multiples in FY20 and FY21 were, naturally, affected by the distortions from the pandemic. If we exclude these years, the long-term average EV/sales multiple from FY13 was 1.1x, and a range of 1.1–1.6x since FY15 when the benefits of the FOTG strategy began to show through in higher levels of profitability that are more consistent with current and expected levels of profitability. The prospective EV/sales multiples for FY24 of 1.4x down to 1.1x in FY26 are at the middle to low end of these historical multiples, suggesting the share price is well-supported.

Similarly for Greggs’ P/E multiple, the FOTG strategy was helpful with a trend upwards from FY13, with an average from FY13 of 18.3x, and an average since FY15 of 19x within a range of 16.5–23.0x, albeit the latter was in FY21 and likely to have been distorted by the pandemic. The prospective multiples for FY24 onwards of 21.9x and lower are therefore towards the mid/upper end of recent average multiples.