I recently invested for the first time in Greggs (LSE: GRG) after the baker’s shares fell following full-year results. So far, though, my Greggs shares have continued heading in the wrong direction.
Selling on a price-to-earnings ratio of 12, Greggs looks like a bargain to me. But if that is the case, why are they not bouncing back from the post-results slump?
Things may get worse before they get better
Earlier this month, I was impressed by some of Greggs’ headline results. Sales grew by 11% year on year, for example, while pre-tax profit was up 8%.
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Not everyone shared my enthusiasm, though – and I think they have a point.
Profits growing slower than sales is the opposite of what ought to happen for a company that has economies of scale in its business. Meanwhile, the headline growth in sales outstripped a more modest growth of 6% in like-for-like sales at company-managed shops.
That matters because growing revenues by opening lots of new shops can work (and Greggs is targeting 140-150 new shops this year, net of closures), but it typically requires significant capital expenditure.
The big concern, though, seemed to be the 2% growth in like-for-like sales in company-managed shops in the first nine weeks of this year. That suggests far lower growth than last year, raising questions about whether Greggs is running out of steam as it tries to get more out of its existing estate, for example, by opening more shops for evening as well as daytime sales.
If like-for-like sales growth falls further, I reckon Greggs shares might also head down further, even if total revenues at the chain continue to increase.
This still looks like a bargain to me!
Still, growth is growth. The company pinned its poor start to the year on bad weather hurting customer demand.
Even if Greggs achieved no like-for-like growth, its aggressive store opening programme could see revenues increase. So too could price inflation. Thanks to its well-known brand and some unique products, the FTSE 250 baker has pricing power.
In fact, even if like-for-like sales revenues were to remain flat (which I doubt will happen), I reckon Greggs looks tasty at its current price.
Pre-tax profits last year topped £200m. The company has a proven, scalable business model and can benefit from further economies of scale due to central manufacturing plants that prepare products to be shipped out to its shop network to be popped in the oven.
I think there is substantial space for Greggs to expand within the British Isles, even before it considers getting serious about the potential to grow overseas.
I see risks too. Changing high street usage could mean less passing traffic. Wage increases following the Budget will take a bite out of profits.
But as a long-term investor, although I recognise that Greggs shares could fall further in coming months especially if sales growth is weak, I also think the current price looks like a potential bargain. That is why I bought Greggs shares earlier this month.
