Last Updated September 5, 2013
I have a pretty simple approach to investing; look for good companies at good prices. It’s not exactly rocket science, but it does require looking at the bigger picture, and the guts to back your own opinion over the market’s.
So what is a good company? Again, that’s pretty simple really. It’s one that’s profitable rather than not profitable, returning cash to shareholders (paying a dividend) rather than not, and growing rather than shrinking.
For most people, if you’re interested in a shrinking, unprofitable and cash-consuming business rather than a growing, profitable and cash-dispensing business, you may be better off finding someone else to manage your money.
Of course I’m stating the obvious. Most investors want good businesses, but what separates the successful from the unsuccessful investor is usually the price they’re willing to pay.
My general rule on price is to buy low and sell high; insightful I know. More specifically, I mean buy when the price is low relative to other investments with similar characteristics (in terms of growth, profits and dividends), and sell when the opposite is true.
So let’s take a look at Whitbread and see where it leads us.
Whitbread – The UK’s leading hospitality business
Whitbread is made up of a group of leading brands which most people will have heard of. Most of the sales and profits come from Premier Inn (the UK’s largest budget hotel chain) and Costa (the largest and fastest growing coffee shop chain in the UK), with the remainder coming from restaurants, including the famous Beefeater Grill.
These are strong, market leading brands, but what has the company managed in terms of financial results?
This is exactly the sort of results I like to see; a relatively steady march upwards over time, at a rate of something like 9% a year. The dividend has been progressive, despite the initial downward trend in earnings, which the company has since reversed. Sales have been more steady, and overall the picture is one of repeated success.
2007 was a year of substantial change, with the company selling its interests in both Pizza Hut and TGI Friday’s, along with some 239 pub restaurant sites. The turnaround strategy since then certainly appears to have worked, with sales and profits up substantially.
Although the company appears financially strong, with manageable levels of debt, one negative point is the pension deficit. I don’t have a hard rule of thumb regarding pensions, but the latest deficit appears to be £521 million, which is about 13% of the £4.1 billion market cap, or about 200% of the average profit in the last three years (at £250 million). Both those measures are relatively high.
Big pension deficits tend not to kill these sorts of large companies, but they can be a substantial drag on performance.
Overall I would say that Whitbread, at the right price, would be a likely candidate for the UKVI model portfolio. If I used a watch-list, it would probably go on it.
Price – the other side of the investment coin
No company is worth an infinite price, and of course buying Coke, Tesco or Whitbread at 1p is better than buying them at 10,000 pence. So clearly a lower price is better, but how can we decide if Whitbread, at 2,300p is cheap or not?
Given that the value of Whitbread should be based on the cash that it can return to shareholders today and in the future, it makes sense to measure cheapness relative to the dividend.
With a dividend of 51.25p, the yield is around 2.3%. That doesn’t compare well to the 3.5% or so that I can get by investing in the relative safety of the FTSE 100.
What Whitbread lacks in yield will have to be made up for with above average future growth. Of course this may be possible, but high future growth is often a dangerous thing to rely on.
Dividends ultimately come from earnings, and with adjusted earnings of around 140p the PE ratio is 16.5. That’s above the market average, but not by a huge amount.
However, as the chart above shows, the most recent earnings really were rather spectacular, and well above what the company has historically managed. This high level of earnings may be indicative of an incredible future which awaits the company, but then again it might not.
The company has switched strategy to a fairly large extent at least twice in the last decade or so. On the one had it shows that management can turn the company towards more successful endeavours, but it also means that the current strategy has little track record to back it up.
This shows up in the price to 10 year earnings average ratio, which is used to reduce the effect that recent earnings have on the valuation ratio. Looking at this longer, cyclically adjusted metric shows that the company is current priced at 29 times the 10 year average earnings of 78.7p.
In most cases a PE10 ratio above 20 is likely to be expensive for most companies, except those with very long, consistent histories of above average growth.
Although Whitbread does have a reasonable history of growth, I don’t think it’s long enough or strong enough to justify such a valuation.
One for the watch-list
With growth rates around 9% and a market leading business with good international possibilities with the Costa brand, I think Whitbread could be a worthy investment at the right price. However, 23p, which is what the shares cost today, is not the right price for me.
At that level the yield is well below average and the cyclically adjusted valuation is far above average. If the shares were around half today’s level at perhaps 12p, then I would probably revisit this company for a second look.
At 12p the yield would be over 4% and the cyclically adjusted PE would be near to 15, a much more sensible starting point. If you think 12p is ridiculously low and likely to never be seen again, you only have to look back to late 2010 to see when the shares were last at that level.
As an investor all I can do is cross my fingers and wish, in the nicest possible way, for a small problem to get blown out of proportion, sparking a panic and a crash in the share price, creating an attractive opportunity for a contrarian, value focused investor to get in.