A leading City analyst has revealed that a possible demerger of the Costa Coffee brand from the Whitbread Group is not on the cards, due to tougher competition and international expansion.
Jamie Rollo of Morgan Stanley reviewed the group’s current position, arguing the BB75 retailer is faced with intensified competition in the UK market from the likes of Tesco and its 49% investment in independent artisanal coffee shop business Harris + Hoole.
He said: “Costa is growing outlets at 15% and profits by 20-30% annually, and will likely stretch its F2016 target of 3,500 outlets to at least 4,000 by FY2018. Although we continue to think a demerger makes sense, given the lack of synergy with hotels, we no longer see a conglomerate discount within Whitbread to support a separation (we estimate its share price values Costa at 26x FY13 P/E), and the timing is not ideal for two reasons: tougher competition and its international strategy may need to change.”
Rollo added that Costa Coffee is under increasing pressure, with new entrants into the coffee shop and breakfast markets, such as Greggs and Lavazza, in addition to non-specialists such as pub businesses.
He said: “Costa has likely gained from Starbucks UK’s adverse publicity, but Starbucks is fighting back. Costa is ubiquitous in the UK: its 1,500 UK outlets make it bigger than McDonald’s and nearly as large as branded catering outlet leader Greggs, but this rises to nearly 8,000 including wholesale outlets and machines. Starbucks’ US density suggests 2,000 outlets might be Costa’s natural UK limit.
“The UK already has nearly twice the density than the US of coffee shops, and our proprietary research shows that for 70% of Costa outlets there is another Costa, Starbucks or Caffè Nero within one mile.
The City analyst also revealed that Costa’s success in the UK puts it in a weak position on a global scale: “Most overseas markets are franchised, so barely register in profits, and expansion targets for the China JVs suggest a maximum of £10-20m EBIT in five to 10 years, so worth perhaps 100-200p per share. Costa will continue to derive 90% of EBIT from the UK, as this is where its highly profitable equity stores are.
“So we think the overseas strategy may need to change, and Costa could consider putting more equity and investment into developed markets, such as France (where it has a trial store). This may mean the international strategy becomes higher-risk, with start-up losses.”