Over the past couple of decades, Greggs (LSE: GRG) has baked up a tasty return for shareholders. Lately though, Greggs’ shares have lost their flavour.
Take the past 12 months as an example. During that period, Greggs’ share price has fallen 23%. So an investor who put in £15,000 back then would now be sitting on a shareholding valued at around £11,550.
There are dividends to take into account too. The current yield is 4.2%. A £15,000 investment in Greggs’ shares six months ago ought now to be earning close to £500 in dividends annually. Still, even allowing for that, the £15,000 investment would currently be showing a paper loss overall.
What’s gone wrong?
Disappointing stuff. After all, no investor puts money into shares hoping that they will shrink in value. So what has gone wrong for Greggs?
Arguably not that much. But it is currently caught in what I would describe as an expectations trap. When I say not that much has gone wrong, I am not glossing over recent challenges.
Last summer saw a shock profits warning. That reflects multiple ongoing threats to the business, from poor product demand planning and stock-keeping for seasonally-changing weather to the impact of higher National Insurance and wage costs.
But Greggs is still growing revenues on a like-for-like basis. That growth looks even stronger when adding in the effect of new shop openings.
The company is still profitable, has a loyal customer base and benefits from a competitive cost structure thanks to its size and some centralised manufacturing.
The rub is – and this is what I termed the expectations trap – Greggs had been seen as a hot growth share for some years. Now the business has got much bigger and organic growth has slowed, investors are marking down the growth premium they think the share merits.
So even though Greggs is still a strong, profitable business and in growth mode, its shares have been pushed down because projected business growth rates are not what they once were.
Is there an opportunity here?
I am not surprised by that declining growth rate. No organisation can maintain high growth rates forever – all reach a point of diminishing returns from business expansion.
With several thousand shops in the UK, Greggs is closer than ever to saturation point. Opening a new shop risks simply taking business from an existing one, rather than from a rival.
Still, is this a bad business? Not at all. I think it is a great business. It has taken a commodity product range and introduced twists like unique names and flavours to help differentiate its offering in the marketplace, giving it pricing power even for basic items like the humble sausage roll.
The company has a compelling value proposition for cost-conscious customers, yet remains profitable and cash generative. Customers come regularly and I expect that to stay unchanged. People need to eat whatever the economy is doing. In fact, Greggs’ cost focus means that a weak economy could actually be more helpful than harmful for customer demand.
I think there is now a fundamental mismatch between what Greggs’ shares should be worth and what the stock market says they are worth. Over the past few months I have added more to my portfolio.
