Whitbread PLC

Whitbread PLC is a hospitality brand with a really interesting story. They are headquartered in the UK with global hotel, coffee shop and restaurant operations. Originally started out as a brewery, they sold all their pub and bar operations by 2001, which initiated their foray into the hotel and restaurants market. Their main brands include:

• Premier Inn (launched in 1987 as Travel Inn)
• UK's largest budget hotel chain.
• 662 hotels, over 47000 rooms - in the UK, UAE, India and Republic of Ireland.
• Makes up 70% of Whitebread's earnings.
• Plans to increase total rooms by 40% (18000) by 2016.
• First budget chain to invest in prime time television advertising with celebrity endorsements.
• Has won numerous awards for both e-sales services and hotel quality.
• Costa (acquired in 1995)
• Coffee shop chain with over 1300 locations in the UK and 800 overseas.
• Second largest coffee chain in the world, largest and fastest growing in the UK.
• Costa Express - 1192 selfservice coffee machines.
• Table Table (launched in 2006)
• Restaurant chain with 116 locations in the UK.
• Beefeater Grill (launched in 1974)
• Pub restaurant with 135 locations in the UK, most with a Premier Inn next door.
• Brewers Fayre (launched in 1980)
• Family and casual pub restaurant chain with 129 locations in the UK. Most are on-site at a Premier Inn.
• Taybarns (launched in 2008)
• British low-cost buffet with 7 restaurants in the UK.

Strategy overview:

• Build strong brands on consistently delivering great customer experience.
• Expand strong UK brands like Premier Inn and Costa into the international market.
• 16Jan12 - "World's Leading Budget Hotel Brand" - 2011 World Travel Awards.
• 12Dec11 - "Occupier of the Year", "Front Cover of the Year" - Estate Gazette Awards
• "Best Value Hotel Chain" - YouGov
• Whitbread is pursuing aggressive growth:
• Expand Premier Inn by adding 4200 rooms/30 hotels and 6 new restaurants by end of 2012.
• 20Apr12 - secured planning consents for 8 new hotels/1000 new rooms in 4 weeks. Leasehold and freehold properties. Open and trading by 2014/2015.
• 29Mar12 - complete deal with Beltane Asset Management to open 184 room hotel in the City of London. London seen as key growth market.
• 16Mar12 - 8 new sites secured totalling over 340000 sq ft, adding 774 rooms. 3 located inside of London, the core growth market. Strong customer demand for Premier Inn.
• 2Feb12 - Completed 120 room hotel and restaurant in High Wycombe. Acquired site from the council to maximise re-use of surplus public sector property.
• 16Jan12 - Submits planning application for 120 room hotel and restaurant in Worcester.
• In 2011, Whitbread opened 4055 new rooms in 29 new hotels and 12 new restaurants - highest organic growth to date.
• Growth in London is a key focus - 7225 rooms vs 14000 rooms by 2016. London hotels will have a similar cost base but significantly higher sales and hence more profitable.
• Expand Costa Coffee by adding 350 new stores globally and 1000 Costa Express machines. Increase system sales to £1.3bn.
• Collaboration with Kraft Foods. Tassimo coffee machine. New revenue stream by bringing Costa coffee into the household.
• By 2016: 65000 Premier Inn rooms in the UK, 3500 Costa stores worldwide, 3000 Costa Express machines.
• Sustainability - reduce carbon emissions by 26% by 2020.
• 26Mar12 - photovoltaic cells installed in 10 hotels. Save more than 42 tonnes of carbon dioxide a year.
• Team mentality and culture.
• 2Feb12 - "Sharesave" scheme meant employees made more the £4.3 million in profit. Employees can save money to purchase shares at a discount.

Company structure:

• CEO Andy Harrison reports to the board of directors - ultimate authority for decision making.
• Chairman Anthony Habgood.
• Executive committee - formed of the MDs of the children companies.
• Management boards - a board exists for Costa and Whitbread Hotels & Restaurants, responsible for main functions and operations.

Business analysis:

• Defensive stock - consistent payment of dividends. Increasing dividends from 36.55 in 08/09 to 51.25 in 11/12.
• Strong, consistent, continued growth in revenue, EPS and profit despite economic difficulties. £1.778bn revenue in 2012.
• Double digit revenue, profit, EPS and dividend growth.
• Premier Inn
• Sales up 8.3% to £755.9m.
• Outperforming the UK economy and midscale hotels. Management is confident of continued outperformance through their Flexible and Saver rates.
• Strong position in terms of financing and debt as it owns over 85% of all hotel freeholds.
• Difficulties facing competitors like Travelodge, who had to taken an emergency bank loan whilst restructuring debt. Limited capital expenditure, which means its original plans to open 3600 rooms may be scrapped and potentially have to close less profitable locations.
• They are continuing to offer £10 rooms which demonstrates the price sensitivity of the market.
• Olympics will provide a significant demand boost.
• Two new non-executive board members: Susan Hooper (significant experience in the travel industry), Susan Taylor Martin (President of Reuters, influence during technological and corporate change).
• Polarisation of the industry into economy and luxury ends of the spectrum. Economy boasts margins of around 60% due to low operating costs and smaller space - highest margins in its peer group of around 45%
• Should property sale be considered?
• Generating cash for capex - more cash generative.
• Provide dividend cover.
• Increase leverage.
• Costa
• Sales up 27.5% to £541.9m.
• Impressive store growth in China. From 21 in 2007/08 to 164 in 2011/12. Projecting 500 stores in 2015/16.
• Like-for-like sales growth of 33%, 17% margins (from 5% in 2009/10).
• Going by their current growth rate and successes, 500 could be a modest target.
• Successes in Tier 2 and 3 cities with combined population of 750m. Currently has 50 stores in 14 cities.
• With economists estimating that the middle-income class will grow at the quickest pace (reaching 28% of total urban households, 76.4m), this bodes well for Costa as a service provider.
• Middle-income class+ will reach 32% of urban households. This increases the Costa target market from 18m households to 87m.
• Using existing UK numbers of customers per store, we arrive at a figure of just under 18000 potential stores in China, compared with 1000 that exists currently.
• Top three areas outside the UK: India (95 stores), Poland (93 stores) and UAE (80 stores).
• Well on track to beat targets as actual growth is significantly higher than implied needed growth.
• Pure hoteliers trade higher at 7-13x EV/EBITDA, quick service restaurants trade on 11-14x EV/EBITDA. Whitbread trading lower due to conglomerate discount.
• Demerge Costa? Worth 30-40% of EV, up to 50% of market cap but only 20% of group EBIT.
• Attractive due to strong market position and growth prospects, better EPS growth than group, better cash generation due to leaseholding property, costs can be met from FCF, easy debt/equity issue if acquisition required.
• Similar to Starbucks in terms of international-local EBIT split (15-85, 11-89 for Starbucks).
• Starbucks profitability ahead due to its scale which is being reduced by Costa growth.

Equity Valuation Techniques: Public Comparable Analysis

Continuing the theme of equity valuation techniques from the last post. We take a deep dive into using public comparable analysis. As mentioned briefly before, along with acquisition comparables, the purpose of this analysis is to compare a company to its peers to derive the relative value.

How do we determine what the peer group is? There are two types of criteria:

• Operational: customers, cyclicality, seasonality, distribution channels, industry, products/services, markets.
• Financial: growth prospects, margins, liquidity, size, leverage.

In order to provide prudent and accurate analysis, a list of public information must be collected for each company. These include: 10-K/annual report for the latest fiscal year, 10-Q/interim filing from latest quarter, news announcements since most recent filing, research and EPS estimates and the current share price.

The latest twelve months (LTM) is commonly used as the period under analysis. This is preferred as it is more recent than the last fiscal year. It also takes in account seasonality of certain businesses which would not be the case if only the last quarter was considered. Finally, it allows for comparability for companies with different year ends.

The multiples (financial ratio) of a company is compared with those in its peer group. These multiples are usually calculated at a point in time, off the current stock price and using all of the public information available. The multiples allow us to compare similar companies and similar transactions. The P/E ratio is an example of this.

• P/E = Current share price/Earnings per share (EPS)
• A higher ratio means an investor is willing to pay a higher price for the stock given the earnings because they are bullish about the future earnings/performance of the company.
• VW - 3.33 ( = 113.17/( 15799000000/465000000 ) )
• Ford - 2.26 ( = 12.04/( 20213000000/3801000000 ) )
• As of 6th January 2012

Multiples must be calculated with the correct underlying financial statistic. For example, for equity holders, they would only care about data which are applicable to shareholders. EBIT would not be very useful as it does not incorporate interest that needs to be paid to debtors.

• Equity based multiples include:
• P/E (price/EPS)
• market value/net income
• market value/book value
• Enterprise value multiples (applicable to all capital holders)
• enterprise value/sales
• enterprise value/EBITDA
• enterprise value/EBIT

These ratios are driven by three main factors:

• Size - dominance, market capitalisation, enterprise value
• Risk - operational efficiency, productivity (margins, return on investment capital, ROIC), financial risk (credit profile)
• Growth - cash flow, EBITDA, net income or EPS, sales

Forward multiples can also be used to value a company. A consensus of analyst estimates can be found on websites like Reuters, Bloomberg, Yahoo! Finance or Zacks.

Looking at the table or multiples above, I believe Volkswagen is fairly valued with an enterprise value/LTM EBITDA of 14.55x. They have shown strong growth in the last 5 years which is forecasted to continue. Although its multiple is less than that of Toyota's, it is also significantly less levered which also reduces its financial risk. Volkswagen trades in-line with Ford and to a less extent, Honda. Despite a higher multiple, it is also more levered and less profitable but I believe this is offset by the higher growth.

Equity Valuation Techniques: EBIT

My previous post was an attempt at valuing Ralph Lauren from some knowledge I gained during university on the Accounting course and from my wider reading. I want to use this post to explore more valuation techniques used in the industry.

The goal for every firm should be the creation of value or wealth for its shareholders. Therefore, understanding the value of the company is vital in order for an investment decision to be made. However, components of valuation can be subjective due to the different interpretations of data as well as the "story" of the company. That said, there are many quantitative methods such as ratio analysis to help paint the picture. Using a combination of both we should arrive at a congruent and reasonable valuation for the underlying company.

There are several ways to estimate the value of a company:

• Public Comparables Analysis - relative value to its peers.
• Acquisition Comparable Analysis - relative value based on historic transactions in the industry.
• Discounted Cashflow Analysis (DCF) - calculates the intrinsic value of a firm by projecting estimated unlevered free cash flows and calculating the present value.

What will someone pay? There are many factors to consider, for example Common Affordability Analysis can be done:

• Merge consequences  analysis - impact to the financial position of a buyer and determines what they can afford to pay for a target company.
• Leveraged buyout (LBO) analysis - when the buyer is a private equity firm primarily funded with debt.

As well as other factors that needs to be considered. For example, a strategic buyer (e.g. competitor) would be willing to pay more than a financial buyer like a private equity firm. Also, hostile takeovers tend to drive up share prices more than friendly acquisitions.

As Volkswagen AG was another company I was bullish about at the beginning of the year, let us use them as an example for the rest of the analyses.

The simplest ways to estimate the value of a company is by looking at the equity value, also known as the market capitalisation. From the official "fact sheet" we can calculate the market cap to be €35.13bn (119.05 x 295,089,817), which includes the diluted shares disclosed in their latest income statement. This gives an indication of what current investors thinks the company is worth. With this metric, we can also calculate the enterprise value, which includes the value of both equity and debt:

Enterprise value = Equity Value + Total Debt - Cash & Equivalents

• Equity value = €57.54bn
• Despite calculating the market cap above, in order to maintain consistency we will use the value from their latest (2011) balance sheet, under equity attributable to shareholders of VW AG.
• Diluted shares should be used which includes all options, warrants and convertibles. The treasury stock method (TSM) assumes the proceeds from in-the-money options exercised will be used to buy existing shares of common stock and minimise the dilution from the options.
• Total Debt = €93.53bn
• Including interest bearing, current and non-current financial liabilities.
• Cash & Equivalents = €18.29bn
• Enterprise value = €132.78bn

Earnings Before Interest and Taxes (EBIT)

• Influences the equity and enterprise value. Quantifies the income from operations before the effects of financing and taxes, highlighting profitability from operating activities.
• Ignores the capital structure (division of capital into debt and equity) of the company.
• Comparing the EBIT for VW and one of its competitors:
• VW - €11.27bn operating profit from their 2011 income statement.
• Ford - $11.37bn operating profit from their 2011 income statement.
• This is the raw EBIT calculation, but we also need to normalise the financials to understand the underlying fundamentals of the company.
• We do this by "backing-out" one-times items which may result in gains/losses.
• These can include restructuring charges, legal settlements or gains/losses from sale of division.
• Problems can arise when these one-timers are built into other components of the cash-flow statement. In these situations we must investigate further by reading footnotes or the annual report and making the relevant adjustment.
• We must also understand the impact of these items on the company and whether it will impact the financial health of the company.
• Continuing the examples above:
• VW has a normalised EBIT of €11.05bn
• From here we can see the breakdown of income and backout Income from investment property (60), Gains on asset disposals and the reversal of impairment losses (163).
• Ford has a normalise EBIT of €11.34bn
• From here we can see the specified non-recurring expense of 33m.

Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA)

• Can be used as a proxy for operating cash flow as depreciation and amortisation are non-cash expenses.
• EBITDA can be calculated by adding the depreciation and amortisation back to the EBIT.
• Normalised EBITDA can be calculated by adding normalised D&A back to the normalised EBIT.
• However, it is not actual cash flow, as it does not include interest which is paid primarily in cash.
• EBITDA also does not consider the following outflows:
• Operating activities (working capital needs).
• Investing activities (capital expenditures).
• Financing activities (cash flows to and from shareholders and creditors).
• For example:
• VW - €21.60 ( = 11.27 + 5.97 + 1.70 + 2.67) from their 2011 cash flow statement.
• Ford - €16.75 ( = 11.37 + 5.38 ) from their 2011 cash flow statement.

Ralph Lauren Corporation

When I first started constructing my simulated portfolio, it was at the peak of the eurozone debt crisis. Due to the uncertainty in Europe and with "safe havens" offering negative real interest rates, I looked towards the equity markets for returns, especially from iconic brands. According to Stock For The Long Run by Jeremy Siegel, stocks have significantly outperformed any other asset class over a long period of time, and although controversial, it is generally accepted that there is a positive equity premium. Of course, there are flaws in the argument presented, for example survivorship bias and relatively small data size.

(This piece of research was done in early January but I still want to capture my findings in one centralised space.)

Ralph Lauren Corporation:

• Price paid: $145.71
• Summary:
• Ralph Lauren is a lifestyle company, specialising in high-end menswear, womenswear, accessories, fragrances and houseware. There is a multitude of brands and subsidiaries under the Ralph Lauren umbrella with the most well known being Polo Ralph Lauren.
• Three main revenue drivers:
• Wholesale - selling products to third party retailers. Products sold in over 10,000 stores and have invested over $35m to provide the RL aesthetic.
• Retail - selling directly to end consumers.
• Licensing.
• Averaged 22% earnings growth in the last 5 years with rising earnings last 6 years in a row. They have been profitable every year since going public in 1997.
• However, signs of slowing sales in Europe and Asia but US revenue continues to be strong with the fastest growing sales in 4 years. RL generates less than 1/3 of revenues outside the US with Europe only contributing 1/5.
• There are around 100 stores in Asia which sells RL. To address this issue, they have opened Ralph Lauren flagship stores in Beijing, Shanghai and Hong Kong to reposition themselves in the Asian markets and take advantage of the surge in demand for luxury products. They are also looking to open company owned stores in second and third-tier cities. This is a conscious decision to move away from concessions/leased space in department stores.
• The relatively young Rugby Ralph Lauren line is also demonstrating strong performance with new flagship stores opening in Tokyo, Japan in 2010 and London, UK in 2011.
• Historical correlation with competitors companies like PVH who are also seeing revenue growths (for example, 21% increase for Burberry).
• Strategy:
• Increased physical and online presence in Asia. This strategy was also employed by Coach in 2008 which led to rapid expansion in China, Taiwan and Hong Kong.
• Increase in exclusive/limited edition products. For example, Rugby launched Covent Garden only bags and accessories to celebrate the opening of the London store.
• Continued wide distribution through both flagship and department stores as well as applying expertise to wholesale business.
• Increasing prices on higher end items to prevent hurting low-income consumers.
• Affiliated with large sporting events like Wimbledon, organisations like the United States Tennis Association, sponsors pro golfers and is the Official Patron of The Open Championship and official outfitter of the US Olympic and Paralympic teams for 2012.
• 176 full-priced stores and 191 factory retail stores allows the company to maximise profits from past season stock without harming the brand.
• Production is contracted with 98% of manufacturing coming from outside the US.
• Personel - the current executive officers all have a consistent track record of success and has been relatively stable. The majority of the board were present during the previous recession and Ralph Lauren performed strongly during the crisis, I believe they have the experience and expertise to direct the company through these difficult macro-economic times. The leadership of Ralph Lauren is obviously critical to the economic success and lifestyle projections of the company.
• Ralph Lauren - Chairman and CEO since founding the company in 1967.
• Roger N Farah - President, COO since 2000. Previous experience at Venator Group.
• Jackwyn L Nemerov - Executive VP since 2004. Previously COO of Jones Apparel Group.
• Tracey T Travis - Senior VP and CFO since 2005. Long history of CFO experience at other large multinationals.
• Recently named Daniel LaLonde President of Ralph Lauren International, who has vast experience in this industry including involvement with Moet and Chandon, LV and head of LVMH's watch department: Tag. He will be overseeing RL's international operations and has specifically targeted Asia as an area of focus.
• Judith McHale (current Under Secretary of State for Public Diplomacy and Public Affairs) named on Board of Directors. (Re)appointed to strengthen their global franchise and develop international relations.
• Financials
• Policy to pay a consistent dividend of $0.20 per quarter.
• Despite being a seasonal business, FQ3 2012 net revenues up 17% from comparable period last year - over 22% growth in both retail and wholesale sales.
• Gross profit up 14% to $1b from same period last year.
• In fact, the company has outperformed each quarter year on year for the last three years without fail.
• Although a P/E ratio of 23.32 TTM is higher than the sector average, it is not outrageously high and perhaps we should not be too concerned.
• Surprisingly, the beta of this stock is 1.52 which compared to 0.92 of the sector means we have to generally be cautious due to higher price volatility. However, it also means we can expect higher returns than the market, and with indications of US recovery and upticks in the US equity indexes, we can expect this stock to outperform significantly.
• Ralph Lauren's real strengths lie in its financial stability. With both the current ratio (2.72) and quick ratio (1.81) significantly above industry average, it demonstrates they are able to meet short-term liabilities with ease. It also shows their ability for quick inventory turnover reinforcing their strong sales results. 
• Looking at the Days Sales Outstanding (approx 27 days) and Inventory Turnover (0.78), we seem Ralph Lauren outperforming direct competitors like PPR, Burberry and Richemont. It demonstrates their ability to quickly turn inventory back into working capital for reinvestment.
• Being leveraged at 1.57, close to the industry norm shows their reluctance to take on further debt, possibly because of the cost of borrowing will eat into profit margins. However, looking at their working capital and current ratio, it seems like lack of funding is definitely not a concern for the company.
• Return on invested capital of nearly 3% is also higher than their closest competitors. This metric is used as it takes into account the cost of finance and gives us the opportunity to back out amortisation and goodwill.
• Price target of around $180 by mid-August.
• Shorting the Dow Jones US Apparel Retail Index could be a useful hedge to highlight Ralph Lauren's performance against the rest of the industry. 

It will be very interesting to see their FQ4 2012 results on 22nd May 2012. I will do a follow up if my estimates/views need amending.