Whitbread PLC WTB LN
November 30, 2015 - 11:00pm EST by
ci230
2015 2016
Price: 4,500.00 EPS 238GBp 266GBp
Shares Out. (in M): 183 P/E 18.9x 16.9x
Market Cap (in $M): 8,714 P/FCF 0 0
Net Debt (in $M): 726 EBIT 605 684
TEV ($): 9,445 TEV/EBIT 15.6x 13.8x

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Description

Whitbread PLN (WTB LN) offers a unique opportunity to buy a business with two best-in-class regional franchises in attractive industries (coffee shops and budget hotels), at an inexpensive price, with stellar organic growth prospects, under temporary price pressure, and with the potential for near-term corporate actions to unlock value.  I believe the stock is worth between 6500 and 7500 GBp, representing 45-67% upside from today's price.

Why does this opportunity exist?

1. Whitbread is underfollowed by the US hedge fund community.  There are no posts about the company on VIC, SumZero, (CoB&F), and Seeking Alpha.  Anecdotally, most of my contacts were not familiar with the company, and definitely did not know it owns the two leading brands in its segments.

2. Sell-side analysts have been downgrading the stock on: (a) trying to call the RevPAR cycle early, since they missed the top in the US; (b) concern about UK minimum wage increases; (c) the threat of AirBNB on the company's hotels.  I will discuss why these fears are unwarranted later.

The business: Premier Inn

The Premier Inn segment comprises roughly 80% of consolidated EBIT.  The company owns the Premier Inn line of hotels, with 60,000 mainly UK-based hotel rooms.  Based on an analysis of RevPAR, occupancy, and supply growth estimates, it appears the UK RevPAR cycle is several years behind the US.  It is arguable that occupancy, although it has grown each year since 2010, may be peaking, but favorable supply and demand characteristics suggest pricing still has room to grow.

Growth: Premier Inn are really the only UK hotel growing their footprint significantly, with 7-8% unit growth forecast for the next few years.  Additionally, the company is focusing their future hotels in the London area.  While only about a quarter of rooms are in London currently, the pipeline is over 50% London based.  According to management, these rooms have approximately 2x the EBITDA of non-London rooms, so you will have margin expansion as a result of this mix shift.

Advantages: Premier Inn is able to maintain approximately 30% segment margins due to structural advantages.  The company is vertically integrated and owns their hotels and brand.  Over 85% of bookings come directly from the Premier Inn website, so there's no margin leakage to OTAs or aggregators.  All KPIs, customer satisfaction scores, and TripAdvisor rankings have been trending up and to the right.

Concerns: This opportunity partly exists due to unfounded concerns about upcoming increases in the minimum wage and ongoing competition from AirBNB.  The UK government has announced a new National Living Wage that will start in April 2016 at 720 GBp for the over-25 cohort (versus 670 GBp currently) and rise to 900 GBp by 2020, approximately a 7% CAGR.  Undoubtedly this will pressure the earnings power, and the company has given some very conservative estimates to quantify this change, and I have included the effects in my model.  However, this is mitigatedfor three reasons: (a) Independent hoteliers ("mum-and-dads") are subject to the same wage pressure with worse cost structures and will be disproportionately hit, favoring the large incumbents; (b) WTB will be devoting more resources to automation and technological improvements that will eliminate some labor needs; (c) WTB has a higher headcount-per-room than its peers, showing room for efficiency gains there.  On AirBNB, I agree this is a real risk, and I personally have used AirBNB both to rent vacation homes and to rent our vacation home a couple times during peek weekends.  However, the sell side has been cajoled by certain HFs into overblowing this concern.  AirBNB fills a specific niche for customers that want the extra space or kitchen but are comfortable using sheets and towels of questionable hygienic standards.

growth 2011 2012 2013 2014 2015
Rooms 4.5% 6.8% 9.3% 7.9% 7.2%
RevPAR 8.2% 1.8% 1.7% 4.3% 8.0%
Revenue 8.6% 3.2% 3.1% 5.0% 9.1%
Contribution 15% 4% 6% 11% 15%

 

The business: Costa Coffee

Costa Coffee contributes about 36% of consolidated EBIT.  Many people may not know this, but Costa Coffee is the second largest dedicated coffee chain in the world (behind Starbucks), and the largest in the United Kingdom, with approximately 35% market share.  The metrics in this business are off-the-charts, with historical sales growth of approximately 20-25% and operating profit growth of 20-40%; ROIC is over 40% as the company continues to open new units.  

Growth: The unit growth opportunity in the UK alone is significant, and international penetration is still nascent; doubling units should be easy.  Starbucks is about 8x the size (23k units versus 3k).  The company has also successfully grown its Costa Express vending machine business, which is a lower risk expansion opportunity with great returns.  Costa is also benefitting from a secular shift in the UK from tea drinking to coffee drinking, which has significant room to continue.  Finally, Costa hasn't raised prices since the 2011 VAT increase, which means their prices are roughly 10% below Starbucks'.  This gives them an opportunity to raise prices to expand margins and/or offset wage pressure.

growth 2011 2012 2013 2014 2015
Units 20% 17% 16% 14% 10%
SSS 7.8% 5.5% 6.8% 5.7% 6.0%
Revenue 25% 28% 24% 20% 18%
Contribution 38% 39% 29% 22% 21%

 

Catalysts

With the strong unit growth story, good (15.5%) firm-wide ROIC, and pricing opportunity at Costa, I am very comfortable paying 16.9x 2016 P/E and holding the company while it continues to compound; this is cheap compared to other hotel companies (20-24x) and coffee companies (22-28x).  However, we may see value unlocked sooner.  Long-time CEO, Andy Harrison, is leaving at the end of the year.  Additionally, the long-serving MD of the Hotels division recently left.  The company has appointed a life-long banker, Alison Brittain, as new CEO.  Previously, she was Group Director, Retail Division at Lloyds (and, before that, she was at Santander UK and Barclays.  The Costa Coffee MD is still with the company.  I think it's possible Brittain may be pressed to spin out Costa Coffee, or try to highlight its value in other ways.  This makes a SOTP valuation credible, and puts valuation to between 6500 and 7500 GBp, representing 45-67% upside from today's price.  The company is also underlevered (2x) and has balance sheet optionality.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Continued strong performance and execution at both divisions; SOTP realization through corporate action or investor pressure.

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