Today’s results show that although sales growth slowed to 9.7%, down from 13% last year and 20% in 2015. But the café chain maintains a good margin on profits. It is building up its cash balance to £20m, as the pace of expansion is modest, where capital expenditure is below £10m.
It has done a deal with Sainsbury’s to supply their bakery in 18 counters, as well as aiming to open another 20 stores for next year. The average payback period is 23 months and Patisserie says each store opened becomes profitable in their first month.
At 21 times earnings, is there more share price growth? Or, will slow sales growth will eventually hamper profit growth, therefore halting the share price appreciation?
To analysis this question, we need to look at four areas of Patisserie Holdings:
1). Mission Objective;
2). Quality of earnings;
3). Profits converting to cash;
4). ROCE and Capex to depreciation pattern;
5). Long-term share price projection.
Before that, here is a brief look at Patisserie Holdings.
A Brief Look at Patisserie Holdings
Patisserie Holdings is the owner of high-end cake shop Patisserie Valerie, as well as Phillpotts, Druckers and more.
In 2014, Patisserie got listed in the market at £1.70 per share, valuing the business at £170m. Today, the shares at £3.36.
At the start it was on a multiple of 18 times earnings, this jumped to 30 times earnings when the share price peaked at £4.50 in November 2015, before settling at £3.36 at 21 times earnings.
Here are the five important factors that investors need to keep their eye on when assessing a business such as Patisserie Holdings.
Patisserie Holdings Mission Objective
Luke Johnson, the entrepreneur who took over Patisserie back in 2006 told The Guardian back in 2014 (before it got floated) that there is a potential to open 250 new sites in the UK. Back then it has 138 new stores, which means a potential of 388 stores.
Today, the number of stores opened totals 199, so there is potentially up to 9 years of growth if we go by the annual increase of 20 per annum. This gives investors direction of where Patisserie is taking their business.
But, what we don’t know is will the café chain maintains their operating margin to grow the share price.
Does Patisserie Holdings have Quality Earnings?
Patisserie is delivering on their promise of expansion without compromising on profit margin.
They managed to increase operating profit per store from £82.4k in 2012 to £101k in 2017, while the number of stores in operation has more than doubled.
That is impressive from Patisserie and shows the potential of expansion as demand from consumers remain high. It also tells us the business model is working as it pursues modest growth.
One fact of Patisserie Holdings success is the company payback period.
It typically cost them £250k to fit out a new store. This becomes profitable in the first month with weekly sales of £14k resulting in an average payback period of 23 months.
Fun Facts: Luke Johnson has experienced in the food service industry and has been involved with Pizza Express, Giraffe and Strada.
Patisserie Holdings is turning profits into Cash
Normalised EBIT has risen in a straight line (see black bar chart). But, more importantly, profits are being converted into cash. If you see the red bar chart hovering above 100, then all operating profit has converted into operating cash profit. For Patisserie, it has averaged 110 for the last five years.
Today’s results showed operating cash profit is 1.2 times greater than operating accounting profit. (1.2 = 120, referring to the above graph)
Also, this shows in their cash and cash equivalent as it rose from £0.5m in 2015 to £21.5m. That’s despite paying out £3.2m in dividends.
Patisserie maintaining ROCE
The biggest increase in the number of stores was in 2014, an increase of 40. Now, the rate of new stores is at a moderate pace (20 per annum) meaning less capital expenditure (under £10m).
As long as Patisserie maintains their profit margins, the company would see ROCE above 20%. While at the same time experiencing declining capex/depreciation ratio.
The pace of expansion has fallen from 2.8 times to 1.58 times over depreciation.
(P.S. Always include acquisitions to capex for accurate measure of company’s growth.)
Finally, we move onto the most interesting factor.
Long-term share price projection
Right now, Patisserie PE Ratio is around 21 times earnings. Investors want to know if there is further decent upside to the share price. To analyse this, we need to evaluate the change in the following financial data:
1). Profit growth;
2). Sales growth;
3). PE Ratio;
4). Profit margin;
5). And, cash balance.
Next, you need to establish a period. Let’s say for the next 10 years.
Since 2012, sales growth has averaged 19%. Today’s results show sales growth at 9.7%.
Since 2012, profit growth has averaged 22%. Today’s results see growth slows to 16%.
In the next ten years, assuming sales growth will average 6% and profit growth 8%. That means by 2027, sales will grow to £204m and net profit grows to £35m.
So, using 21-times earnings, it will give a market capitalisation of £735m. Assuming the number of shares outstanding rise to 105m, then it gives a share price of £7 per share.
Some would say that since growth will slow in the future, then the PE Ratio should de-rate towards 15 times. But then maturity has its virtue as the company begins to pay out more in dividends and build their cash balance while maintaining a “zero debt” balance sheet.
Take cash balance, for example. If we assume for the next ten year the company adds an additional £10m per year, then a cash balance of £120m is equalled to 18% of market capitalisation (similar to today’s level).
The £3.2m dividend payout could rise by 10% for each year, so by 2027 it will payout £8.3m, slightly above 1%.
For a conservative measure, I would give Patisserie a PE Ratio of 18 times (provided it meet the above sales and profit growth), which leaves a valuation of £630m or £6 per share.
It means a modest 79% share price appreciation by 2027. Anything higher is a bonus.
Final Thoughts on Patisserie Holdings
The art of modestly expanding, while keeping an eye on costs is a good business model. So far, the results are good. Under the stewardship of Luke Johnson, I get a sense that his track record at Patisserie, as well as his other venture, would mean he is likely to deliver for shareholders.
So, I’m recommending a long-term buy and expect the share price at £6 per share by 2027.
This is a steady growth business with good margins.
But, always be aware of the new competition.
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The above analysis is based on my opinion and nobody else. It does not constitute professional investment advice. Data is correct on at the time of availability. I don’t hold the company’s shares unless stated.