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Stock of the Day: Whitbread jumps on warmed-up coffee hopes

Stock of the Day: Whitbread jumps on warmed-up coffee hopes

Whitbread investors are stimulated by the prospect of a break-up of the Costa Coffee shop owner, though it’s a reheated one. Activist hedge fund Elliot Advisors disclosed over the weekend it had a 6% stake—the biggest single holding—and made it known it wants the group to split its two biggest businesses, takeaway coffee and hotels. Some major investors have sought such a move for years. The attractions of a split are obvious looking at Whitbread’s valuation relative rivals. Whitbread shares trade at a slightly higher multiple than a clutch of the FTSE All Share hotel and/or pub operators, which average around 13 times earnings expected in 2018. That in itself illustrates Whitbread’s problem. It is the most hodgepodge group amongst close rivals, even after selling down some pubs in recent years and exiting the brewing business entirely.

Costa continues to be a differentiator and a weakness due to the chain’s closer similarity to a retailer than the hotel business, including in terms of volatile sales trends. Costa also contributed lower revenues than Whitbread’s Premier Inn & Restaurant division in 2017 (37% vs. 61%), whilst at 13%, gross margin at Starbuck’s main UK rival was weaker than the 24% from hotels. Investors have shown their distaste at the coffee/hotel mix. Whitbread’s total debt and equity value trades at a far lower multiple of 9 times 2018 earnings than InterContinental Hotels’ 14 times. The crux of the matter is that Costa has no listed direct peer in the UK, meaning Whitbread shares are punished for Costa shortcomings more than they’re rewarded for Premier Inn strengths.

That’s one reason why Elliott wants Whitbread to break out Costa, which made £158m operating profit last year, and list it separately. The idea is that allowing investors to value the two sides separately would create more value; as much as £3bn more in terms of market cap, according to Elliot, bringing the total of the two to £10bn. The strategy differs however, from the one another large activist wants Whitbread to pursue. Sachem Head revealed a 3.38% stake earlier this year saying it wanted the group to get shot of Costa entirely.

So, the attractions of a break-up are indeed obvious. Costa also has a separate management and legal status which would make a separation relatively inexpensive and straightforward. So far though, these attractions have not tempted Whitbread’s board, or CEO Alison Brittan, who has led the group since late-2015. The group has yet to offer public comments on the news. In theory, it could continue to ignore the 10% odd outstanding stock now owned by pushy investors, though that would be unwise. The rules on board seats are less clear cut in the UK than the U.S., but if Elliott and Sachem decided to jointly push for changes, pressure to allow them an official voice would grow. The stock’s near-term trajectory will be less volatile if Whitbread finds common ground. Even after Monday’s 7% spike, it is barely up 2% over a year. Earnings scheduled for 25th April will now see heightened attention. More so if Whitbread remains inhospitable to the idea of a Costa-Hotel split.


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