Costa coffee and Premier Inn owner Whitbread(LSE: WTB) saw its stock peak three years ago and the share price is around 22% down since then. The rate of annual earnings growth slowed from chunky double-digit percentage increases starting with a two, down to single-digit figures, and I reckon the stock has been marking time to allow the firm’s valuation to compress – a lower price-to-earnings (P/E) rating fits better alongside lower growth figures.
Activists on board
However, the shares shot up around 14% recently when US activist hedge fund Elliot Capital Advisers took a stake of more than 5% in the company, mainly via derivatives. Analysts at US investment bank Morgan Stanley reckon the activist shareholder count now stands at more than 9%. These activists seem to want Whitbread to spin off its Costa brand as a standalone company, which Elliot Capital Advisers reportedly reckon will unlock around £3bn of value for investors.
I’ve long seen the fast-growing Costa brand as the jewel in Whitbread’s crown. I think the coffee business is more defensive than the massive cyclical fluctuations we tend to see in the hotel sector when the macroeconomy undulates up and down. Premier Inn has been growing well, but when the world economy dives in the future, I reckon Premier Inn will fall harder than Costa because of the addictive nature of coffee. When times are tough, people will more likely forego a hotel stay than they will their regular caffeine ‘fix’. On top of that, this table from the half-year results report convinces me that Costa is the better-quality business:
|
Return on Capital |
H1 FY18 |
FY17 |
H1 FY17 |
|
Premier Inn |
13.4% |
13% |
13% |
|
Costa |
39.9% |
45.4% |
41.8% |
|
Whitbread |
15.4% |
15.2% |
15.1% |
Yet, analysts at HSBC are sceptical that £3bn of extra value is there to be had. They point to fierce competition faced by Costa from the likes of Starbucks, Caffe Nero, Greggs and premium cafes in cities. They say that “trading is weak and there are not enough cost savings in the business to cover investment and higher staff and commodity costs.”
However, on one level I reckon their analysis is flawed because Starbucks coffee tastes rank and they don’t even mention McDonald’s, which provides one of the best-tasting cups of coffee around these days!
Dangerous companions
The HSBC analysts go on to argue that Whitbread’s largest business, Premier Inn, “is a good asset but relies on a London market that is cooling and bulging with stiff competition.” That is a good point. Cyclicality and stiff competition make dangerous companions for any business and I think they are reasons enough to extract Costa from Whitbread so that the coffee business has the chance to fly.
The recent spike up in the share price added around £830m to the market capitalisation of Whitbread, so on the face of it, there’s still more to play for if a split of the business does ever happen and if it truly does unlock £3bn of extra value. In the meantime, because Premier Inn dominates Whitbread’s business, I’m expecting more stagnation from the share price and more valuation-compression as the current macro-cycle unfolds. My strategy would be to wait for an independent Costa to emerge and then to think about buying some of its shares.