This retailer got a surprising reaction to its latest trading statement.
Earlier this week, there was an episode that might prompt both company directors and novice investors alike to wonder if the stock market is at all rational. And it's instructive to pick through the sequence of events and their background, in order to better understand what went on -- so as to be better able to profit from such opportunities in future.
The events in question concern a retail company that's been doing very nicely out of the recession. Offering a value-for-money product that people have found appealing when forced to cut back expenditure, sales have been rising, as have profits.
On Tuesday, in its interim management statement, the business announced continuing sales growth, good progress with a number of important initiatives, and its intention to open a significant number of new stores, especially in regions of the UK it is either under-represented in, or has no presence at all. This could be done, it stressed, without cannibalising existing sales.
Good news, surely? Er, no. The market didn't like what it heard. So while the FTSE continued its upwards climb, the company's share price promptly slumped 3.7%.
A tasty plan
The company in question is High Street bakery chain Greggs (LSE: GRG). The Newcastle-based business sells value-for-money 'meals on the go' -- such as pies, pasties and sandwiches -- for six million office workers and shoppers every week, sold from 1,400 stores throughout the UK.
Yet its presence in areas of the country such as Southern England -- especially the South West -- is minimal, and adding another 600+ shops by doubling the existing rate of store opening seems eminently sensible. If a formula works, rolling it out nationally is the logical thing to do.
And not just from a sales perspective. As I wrote back in August, at present prices Greggs appears fully valued, despite the obvious attractions of buying into a business with an impressive 24 consecutive years of delivering dividend growth. So establishing branches in parts of the country that are so far untapped seems a sensible way of delivering further shareholder value.
Yet the market didn't think so, marking the shares down by 3.7%. Why?
Concerns are likely to have revolved around two key issues.
What a difference a word makes
First, there's the question of the cost of the expansion move. Opening up between 60 and 70 new stores each year isn't cheap, and the money has to come from somewhere. Retained earnings is the obvious source of ready cash -- especially in this economic climate -- and so there may be an impact on future dividends.
The company itself paints the story somewhat differently -- if not particularly adroitly.
"Overall we expect that our plans to deliver shop growth and greater efficiency will require total capital expenditure in the business to rise to between £50 and 60 million per annum during this period," it said. "We will finance this investment from our ongoing cash generation."
Hang on! A £50 million store opening programme funded from cash flow? But note the critical word "to", which -- crucially -- isn't "by". Capital expenditure was already on the order of £35 million or so each year, and so what's proposed is an increase of around £15 million. Much more do-able -- and much more affordable.
A stretch too far?
Secondly, investors -- probably rightly -- worry about any big new expansionary move. Yes, it could all turn out wonderfully. But just as often, it fails, leaving management with egg on their faces and investors nursing hefty losses.
And that's particularly true of retailing, which is littered with bodged expansions into new markets and new regions. Look at how affluent South Eastern customers of Morrison (LSE: MRW), for instance, were baffled by the product range on offer in its newly-acquired Safeway stores. Or how Tesco (LSE: TSCO) has struggled to gain traction in America.
Will Greggs fall flat on its face? Well, new chief executive Ken McMeikan knows a thing or two about retailing. He was previously Retail Director at Sainsbury (LSE: SBRY), which he joined in 2005 after 14 years in operational roles with Tesco. And, what's more, Greggs has a history of not just opening new stores, but closing down under-performing ones.
In short, some vast expensive disaster seems unlikely.
Decision time
But the share price slump of 3.7% still remains. A fair, considered reaction? Or a flawed kneejerk response from investors temporarily forgetting the board's experience and its 24-year track record of delivering increasing returns?
My money's on the latter. I'm still not a holder of Greggs, but the news this week makes me far more likely to buy in.
More from Malcolm Wheatley:
Malcolm holds shares in Tesco.
