Bakery chain Greggs (LSE: GRG) has seen its share price soaring so far this year. It has been one of the top performers in the FTSE 350, with the shares up by a massive 82%.
While vegan sausage rolls might have got under the collar of Piers Morgan, they’ve flown off the shelves. But it’s still hard to see exactly why the shares should command such a premium price. The P/E of 32 shows investors are expecting a lot from Greggs, and to be fair, so far it has been delivering. But the key question is: will this continue?
Any company that can tell investors its results will come in ahead of expectations is usually going to see it shares doing very well. And that is exactly what Greggs has been able to do. It served up a treat back in May when it announced that sales and underlying profits for 2019 would be “materially higher” than it had expected, helped by strong demand for its vegan sausage rolls.
In a trading update for the first 19 weeks of the year, the group said total sales were up 15.1% versus 4.7% growth in 2018, while company-managed shop like-for-like sales were 11.1% higher compared to 1% growth in 2018.
The success of those vegan sausage rolls could be an indicator that Greggs has more opportunities that it can exploit as consumer tastes change. Investment in manufacturing facilities and in its product range should help it stay ahead of competitors. Another opportunity to boost profitability is increasing the number of franchised stores it has as part of the store portfolio. This should also have a positive impact on profitability because franchisees will take on a lot of the costs of running stores.
Not so tasty
So far, so good. But less appealing is the combination of the high price an investor needs to pay for the shares as indicated by the P/E, which is more than double what is widely seen as the good value benchmark (around 15). On top of that, the yield – partly as a result of the rise in the share price – is now only around 1.5%, which is hardly appetising for investors. Many other companies listed in the FTSE 350 provide far more income than this. The danger for investors wanting to buy the shares now is that expectations have been raised to a point where the shares are susceptible to being punished for anything that is perceived as bad news. The upside, given how expensive they are, is probably limited.
An increase in costs, a low dividend yield and relatively low margins all give me cause for concern when it comes to investing in Greggs. The share price has risen too quickly from my point of view, making the shares too expensive for the limited growth potential on offer and it’s likely any bad news will now be severely punished. The yield offers no protection against any downside either, so for me right now, the shares look unappealing.
Andy Ross has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.