The Investment Case for Greggs PLC
Why I think Greggs is a solid company at a great price.
Disclaimer: Before we start, I should point out that most people are better off in diversified funds - especially global index funds. Investing in individual stocks is very high risk and I am not recommending anyone to do so - I am merely outlining (in detail) why I have risked some of my own savings in a particular company.
To me, there is something very British about Greggs. It belongs on the UK high street, serving satisfying food at a low cost in today’s inflation-baked economy. Yes it’s generally not the healthiest option in the world, but it can still fit well into a balanced diet (with exercise included).
In London especially these days, it feels almost impossible to do anything without spending at least £20. So when I landed at Gatwick Airport one morning last December in need of a quick breakfast for my train journey into the city, I did not hesitate to step into Greggs. I grabbed myself a warm, delicious bacon and ‘omelette’ roll with brown sauce and a half-decent cappuccino. The grand total for this order? £3.75.
I was extremely impressed.
Profits
You would think that such affordable meals might come at a massive cost to shareholders, but Greggs is a very efficient company.
First of all, its gross margin is very high, ranging from 61%-64% over the past 10 years, likely reflecting the low cost of baking ingredients. On the other hand, Greggs’ net margin (the amount left over after all staff/other costs and Corporation Tax) is significantly lower. The net margin of Greggs has ranged between 5%-8% over the past 10 years, although this reflects the industry average.
Return on Capital
To assess how efficiently Greggs has generated its 5%-8% net profit, we can compare it to the ‘capital employed’ in the business. Capital employed consists of:
The money raised by issuing shares.
Long-term borrowings / liabilities.
Retained profits that have been reinvested (i.e. not paid out as dividends).
Comparing annual profits to capital employed is important because profit growth alone can be misleading. Many investors focus on year-over-year earnings growth without considering how much capital was required to achieve that growth.
For example, if a company takes on large amounts of debt, it may suddenly have a huge cash balance. Even if this cash is invested at mediocre returns, the sheer size of the capital pool might still make profits appear to grow impressively (relative to previous years when there was less debt). But in reality, the business has sacrificed financial strength for the illusion of rapid earnings growth.
This is why return on capital matters: it tells us how effectively management and the core business generate returns from the capital at their disposal.
Over the past 10 years, Greggs’ net return on capital, calculated as Net Profit / (Long-Term Liabilities + Equity), has ranged from 14% to 21% per annum—excluding 2020, when Covid disruptions led to a negative return of -2.22%. This suggests that Greggs has been consistently efficient in generating strong returns on its capital base.
So the shareholders are served well. What about the customers?
Public Perception
Greggs generally sits well in the mind of the British consumer. Let’s be honest, we love sausage rolls (even if we feel like crap afterwards), we love pastries, we love bacon/sausages and eggs in the morning, we love a bargain - this is who we are.
If you don’t believe me, see this YouGov poll:
Whether you filter the YouGov poll for millennials, baby boomers, gen x, men or women, Greggs tops the list every time.
Valuation - Why I think Greggs PLC is a bargain
At the time of writing, Greggs’ shares are down around -26% since the start of January this year. This is due to the cost of Employer National Insurance rises, a gloomy UK economy and that Q4 of 2024 revenue growth was slower than expected. For me, such headwinds are drops in the ocean for a long term investment.
If we are headed for economic stagnation, Greggs may well suffer. But since the baker is loved by the public and provides such affordable food, this indicates that they will perform relatively well - thus entrenching their position for better years ahead.
Due to this year’s sell off, Greggs’ price-to-earnings (P/E) ratio is now around 15x. I think it’s unfortunate that PE ratios are the norm because they can appear confusing and too abstract. I find it much more insightful to flip it round like this: 1/15 = 6.67%.
This 6.67% represents the ‘earnings yield’ of Greggs. It’s similar to the rental yield when you buy property. It’s the current annual net income divided by the market value of the asset.
Imagining that profits stay at the same rate as the previous 12 months of available accounts, this means shareholders who buy in at the current price will indirectly get a 6.67% annual return on their investment. I say indirectly because it is usually up to Greggs’ board of directors how much of the annual profit will be paid out to shareholders as dividends and how much will be retained in the business for more productive activities like opening new chains.
6.67% is a pretty good yield if you ask me. Most people focus on the dividend yield, which is generally a mistake. If you own a high quality business you shouldn’t want to receive dividends - you should want the business to keep reinvesting your profits on your behalf, thus compounding the underlying value of your stock.
A 6.67% return is obviously a good thing but of course it comes with its risks as profits can fall. As we have seen in the past, however, profits can definitely rise and in the case of Greggs they are more likely to do so in a sustainable and efficient manner over the long term.
A few more reasons why I like Greggs
Greggs is a low-debt company: Gregg's long term liabilities mainly consist of its leasing obligations for renting its physical locations (including stores, bakeries and distribution centres). Especially now that we are in a higher interest rate environment, it is very comforting to know that Greggs can achieve sustainable success without the need for debt.
Attempting a franchise model: Around 20% of Greggs' stores are franchised. When done right, this is a superb business model as the franchisee risks their own capital while Greggs provides its strong branding and infrastructure in exchange for fees/royalties.
Vertical integration: Greggs effectively controls its supply chain, maintaining high standards of quality and freshness. Food is prepared and produced in central bakeries and then distributed to various centres across the country. From these centres, goods are delivered daily to all of Greggs' stores.
So am I confident about owning Britain’s favourite high street dining brand that is well-run and offers great value to customers and shareholders? Yes.
Could I be wrong? Absolutely.
Why I could be Wrong
Not everything about Greggs is perfect:
Employee satisfaction: I cannot see much evidence that employees tend to love working at Greggs but I am sure the overall experienced is very mixed. I would say this is to be expected given the industry but it would be ideal if things were better on this front.
Tight net profit margins: As mentioned already, Greggs usually operates on single-digit net margin of around 5%-8%. While Greggs is generally good at managing costs, having such tight margins makes the company more vulnerable to shocks that reduce sales and/or increase expenses. Since shareholders don't like incurring losses (especially for prolonged periods), Greggs could be forced to act quite quickly in managing its margins which could involve redundancies, store closures and price hikes to customers. Higher margin businesses do not have the same stress and chaos - although high margin industries tend to be more dangerously competitive because there is more incentive to enter the sector.
Limited global reach: I have almost no faith in Greggs' ability to open successful stores outside of the UK since there would be major cultural and economic barriers to overcome. This means they are limited to the UK market, where 100% of their operations currently exist. Greggs does not operate in the Republic of Ireland, so perhaps this could be worth considering, however Greggs' attempt to operate some stores in Belgium in the 2000s proved to be a failure.
Limited growth potential: As of December 2024, Greggs has 2,618 shops in the UK. This is already quite a lot and makes me wonder how close they are to maximum UK capacity - for instance McDonald's has 1,450 restaurants in the UK and Ireland combined, Dominos has 1,300 (UK and Ireland), Subway has around 2,500, Costa has 2,677 cafes and Starbucks has 1,200-1,300. Greggs has an ambitious target of reaching 3,000 stores but then what?*
*Some counterpoints to the limited growth potential: Physical growth is limited however online deliveries (i.e. Greggs' partnerships with Uber Eats and Just Eat) can increase availability. Also by adjusting the menu at Greggs, they can target a wider audience thus gaining more customers. The most famous example that comes to mind is when they added the vegan sausage roll to their menu, which annoyed Piers Morgan thus further adding to the publicity. They seem to be having some 'viral' recent success with a mac and cheese dish and they also try to include some 'healthy' items on their menu but I am not aware of their popularity.
Thank you for reading. Remember that this is not advice and past performance is not a guarantee of future performance.