Sometimes it pays to focus on quality, not price. One example of this is Whitbread (LSE: WTB), which owns Costa Coffee and Premier Inn.
Whitbread’s sales rose by more than 50% to £3.1bn between 2013 and 2017. The group’s after-tax profits rose by more than 40% to £421m during the same period. Yet despite heavy spending on expansion, net debt has remained modest and the dividend has risen by an average of 11% per year.
Stocks like this can often appear expensive. But what’s interesting about Whitbread is that its shares have got cheaper over the last couple of years. At about 4,000p, the stock currently trades 26% below its 2015 peak of 5,430p. Is this a buying opportunity for far-sighted investors?
A tidal wave of cash
This week’s trading update suggested that growth remains steady. Total sales grew by 7.6% during the first quarter of the firm’s financial year, with like-for-like sales up by 2.9%.
However, what interests me more is this company’s ability to generate cash. Last year, it generated £626.1m of cash from operating activities. That’s 13% more than the group’s operating profit of £552.7m, giving a very impressive cash conversion rate of 113%.
Just £167.1m of this cash was returned to shareholders as dividends. The majority was spent on maintenance and expansion, as Whitbread opened 225 new Costa stores and 3,816 new hotel rooms last year. But this rate of growth won’t last forever. When expansion slows and the group’s business matures, a lot of extra cash should become available for shareholder returns.
The risk, of course, is that management will expand too far, perhaps leaving Whitbread saddled with excessive debt or a high number of unprofitable leases. But there’s no sign of these classic errors yet.
The stock currently trades on a forecast P/E of 15.6 with a prospective yield of 2.5%. I believe that this could prove to be a good time to buy.
Follow the inside money?
Whitbread is already highly profitable. Management’s challenge is to ensure the group stays on track. But for Greg Fitzgerald, the new chief executive of Bovis Homes Group (LSE: BVS), the challenge is different.
Whereas rivals like Persimmon are generating operating profit margins of about 25%, Bovis only managed 15.2% last year. Worse still was that this was 2.1% lower than during the previous year. Mr Fitzgerald’s task is to solve the firm’s operational issues and close the profitability gap with key rivals.
He spent almost £2m on Bovis shares this week. That’s roughly three times his £650,000 annual salary — a decent-sized purchase. I believe this deal is a sign that he’s quietly confident of success.
Should you follow his example and buy Bovis? It’s worth remembering that his remuneration package includes an annual bonus of up to 100% of salary, payable in shares. These ‘free’ shares will lower the average purchase cost of his stockholding considerably, making positive returns far more likely.
Despite this, I’m optimistic. Mr Fitzgerald is highly regarded in the housebuilding sector and should be able to fix the firm’s problems. If he does, then I can see the shares returning to the 1,100p-plus level last seen in 2015. In the meantime, the dividend yield of 4.7% is worth having. Bovis remains a buy, in my view.