I bought some shares in Greggs (LSE: GRG) earlier this year and plan to hold them for a while. Even now, I think Greggs shares are potentially heavily undervalued relative to the firm’s long-term prospects.
In fact, as a long-term investor, I reckon my Greggs shares could rise in value over coming years by a lot from today’s level. Here are three reasons why.
1. Scaling up a proven model
Greggs ended last year with 2,618 shops. A decade before, that figure was 1,671. In other words, that decade saw Greggs’ estate grow by 57% — from an already large base.
What will the coming decade bring?
Last year saw Greggs open a record number of new shops. It is targetting a net total of 150 openings this year alone and has said it continues to see a “clear opportunity for significantly more than 3,000 UK shops over longer term”.
That is in the UK alone. I reckon Greggs has massive potential to expand to adjacent markets such as the Irish Republic and the Netherlands, although it has not announced plans to do so yet (given its growth prospects in the UK, that strikes me as smart for now).
With a proven business model and growing centralized manufacturing capabilities, Greggs ought to be able to realise substantial economies of scale.
2. Expanding Greggs’ reach further across the day
When you get hungry in the middle of the night, do you think of buying something from Greggs?
It is unlikely – and until recently, most people only associated the chain with mornings and lunchtimes. But it has been expanding its offering in the evenings to try and take a bigger share of dinnertime spending.
That strikes me as a potentially massive opportunity.
Evening sales are only 9% of company-owned shop sales at the moment. As one of three key meal occasions during the day, on a simple level I think they could eventually account for 33%, but without eating into breakfast or lunch sales.
That could be a sizeable boost to revenues and profits, as at the moment many Greggs’ shops are sitting unused for a lot of hours each day.
3. Improving profit margins
Last year, Greggs’ pre-tax profit margin was 10.2%. That is not that far off double the 5.4% of a decade ago.
As the company scales up its operation further and utilises its existing assets like shops more, I think the profit margin could grow further.
That could produce a double whammy in terms of earnings per share, as revenue growth combined with higher profit margins push up earnings per share substantially in years to come. In the past decade, Greggs’ diluted earnings per share grew 488%.
I’m holding!
With a price-to-earnings ratio of 14, I think Greggs shares look cheap given the business prospects.
There are risks, of course. Any prolonged shutdown of shops as seen during the pandemic could hurt revenues and profits badly (as it did for Greggs then). Opening too many shops could risk taking sales from each other rather than adding incremental growth.
But I think the valuation ought to be higher – and a combination of strong revenue and earnings growth in years to come could push it there. I have no plans to sell my Greggs shares.
