Greggs (GRG): Food For Thought

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3 mins. to read
Greggs (GRG): Food For Thought

There is an old saying that ridiculously overvalued shares can get even more ridiculously overvalued. Competitive markets may be perfect (the theory that public knowledge permeates every corner of the public domain) but those who buy and sell shares know they are far from perfect in the everyday meaning of the word. Greggs which was well overvalued a month or so ago looks even more overvalued now.

Anyone looking at the history of Greggs’ business and share price will see that it is a bit of a cyclical company with a volatile history and with profits up and down like football fans at a good game. Its dividend history in particular tells us that this is a business that has good years and poor years, and that they can be consecutively very different, one year compared with another. The growth in the Greggs dividend has been of the shrinking violet variety; hardly noticeable as a five year growth figure. Earnings growth has swung between pedestrian to, recently, dynamic.

From and including the year to January 2011, the annual change in earnings has been plus 11%; plus 4%; minus 2%; plus 21%; and finally a mould breaking 43% last year.

Yet it is a share that is valued at a majestic near-26 times the 44p of earnings for the year just ended to 31st January 2015 (earnings rose a remarkable 43%) and nearly 23 times the earnings estimated for this year to 31st December 2015 (the year end having been changed).

It is not merely the price to earnings ratio that suggests these shares are overvalued. The shares are selling on 1.5 times revenue which seems a bit on the high side. Moreover, net assets are reported as only 230p a share (unusually low in the history of this share price). So knocking that off the market price to discern what is being paid for earnings alone, we can see that the ‘pure’ price to earnings ratio is still about 21 times – a still princely price to earnings relationship. Looking further ahead the current market consensus estimates are for earnings growing to a forecast 55p next year. That produces a price earnings ratio of 21 times – again surprising in the light of the history.

My problem is that although I have always liked the Greggs business model of a direct supply relationship with its customers – not having to supply through a supermarket – and its lack of debt, I find the current ratings pretty high even if it were possibly bid for. It is true that Greggs has produced some spectacular earnings growth with its outlet revamp. But that has to be seen against the background of considerably less spectacular earnings growth in earlier years. Has the company changed fundamentally in some way that means that Greggs is now a growth stock? Are we to assume that earnings will grow annually at 20% or more in future to justify the current rating of the earnings?

My guess is that part of the explanation may lie in the fact that supermarket stocks have been so unattractive that money has been looking for growth elsewhere in the food retail sector. Greggs has had a period of outstanding profits growth, no doubt about it. A short time ago it had a market cap. of only £600 million. It was scarcely big enough to absorb a lot of new demand without causing the share price to rise disproportionately, even in relation to the earnings growth of last year.

Personally, I find difficulty in seeing the shares as good value at this level. The rating pays no regard to the history of earnings growth of Greggs over a fuller five year period and too much regard to the exceptional growth last year.

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