Whitbread is entering a new era after selling Costa Coffee to soft drinks behemoth Coca-Cola, concentrating on cementing its leading position in the UK hotel market and expanding overseas, starting with Germany. But is Whitbread’s future, powered by Premier Inn, still as bright without Costa?
Whitbread has been investing to expand both businesses and the slowdown in growth at its hotels division over the past two years correlates with falling capex over the same period, although it is still opening more rooms at a faster rate than it is growing revenue. At Costa Coffee, the declining profitability has been partly down to the accelerating expansion. It expanded its international network by 13% last year, although some will be wary that revenue growth has slowed for at least four consecutive years.
By the end of last year Whitbread had cleaned up both its operations, offloading all non-core assets in order to streamline the business and in preparation for the separation. The firm has closed down its owned Costa operations in France and exited 11 hotels in India, Thailand, Singapore and Indonesia.
What is the value of Costa Coffee to Whitbread?
Costa, which serves 23.5 million coffees each month, has been the UK’s favourite coffee shop for eight years running according to YouGov, significantly outperforming its rivals with a brand preference score of 36% last year, compared to just 13% for Starbucks and 11% for Caffe Nero.
Today, Costa Coffee is present in over 30 countries and has also been growing a new revenue-generating business by installing Costa Express vending machines in convenience stores and other similar outlets, providing a self-service option to access areas where it may not be able to open up a shop, or where it may not be worthwhile opening a costly store. It now has over 8000 machines in eight countries.
Costa Coffee five-year financial performance
As a complimentary service on the high street Costa has suffered from dwindling footfall, but has managed to offset that by expanding the Express service. Whitbread has been refurbishing stores (including a new store concept), introducing new products and investing in its digital proposition in an effort to revive UK sales, which has weighed on profitability. Despite growing profit overseas, doubling last year to £8 million, Costa’s overall pre-tax profit has fallen over the last two years.
Read more about how the UK high street is performing and what the opportunity is
Why did Whitbread sell Costa Coffee?
A ‘significant majority’ of the £3.8 billion in net proceeds, considering £100 million worth of costs, will be returned to shareholders. But Whitbread also intends to reduce its debt and address its pension deficit.
Importantly, net debt and the deficit were already contracting. Whitbread’s pension deficit stood at £289 million at the start of March, having already contracted from £425 million a year earlier, and net debt fell for a second consecutive year to £833 million, from a peak of £910 million in 2016. Gearing is low, with net debt equal to just 1 times annual earnings before interest, tax, depreciation and amortisation (EBITDA).
Whitbread sells Costa to create headroom for expansion and returns
Whitbread had agreed in March 2017 to plug the pension deficit by pledging to pay £85 million annually starting in the current financial year and for the three years thereafter, with a final one-off payment of £57 million in the financial year to end in 2023. It also agreed to accelerate its contributions if the dividend grew by more than 5% - which was the case last year when its dividend was raised 5.6%. The decision to tackle its debt is significant, as it provides headroom for Whitbread to carry out its strategy for Premier Inn and the rest of its growing hotels business while installing confidence that it can keep growing dividends without Costa.
The company has so far managed to cover all basis with its own cash flow, generating £877 million last year. After deducting expenditure it was left with £57 million of net cash flow for the year, which was used to reduce debt. Spending included, but was not limited to, £396 million on its expansion of both businesses, £159 million on maintenance, £101 million on pension contributions and £178 million worth of dividends.
Whitbread passes on Costa’s Chinese challenge to Coca-Cola
Although Costa has entered in numerous geographical markets the biggest opportunity is considered in China, where it has a solid foundation to build upon. It will need it considering how far behind it is relative to rivals like Starbucks. Costa has over 460 shops in China, 250 of which were covered by the partner buy-out last year – but that is nothing compared to its US rival which has over 3300, with about 600 Starbucks in Shanghai alone.
Although Coca-Cola will undoubtedly shake-up existing plans for Costa set by Whitbread, it has already committed to maintaining if not accelerating the ongoing international expansion by using Costa as a platform to move into coffee internationally. It is clear Coca-Cola has financial firepower that Whitbread will never have, and that might be needed if Costa is to make a serious challenge outside of its home market. Whitbread’s plan was to have 1200 stores in China by early 2022 (about 185 net opens per year), but that would have done little to capture market share from Starbucks, which is aiming to have 6000 stores in China by that time – 600 new openings each year, or one every 15 hours.
While there was little doubt behind Whitbread’s plans to expand Costa internationally it has saved itself the huge task of breaking into new markets against more established competition, passing on the challenge to a more suitable owner that has the resources needed to propel Costa to the forefront of coffee on the world stage.
Why did Coca-Cola buy Costa Coffee?
The price of Costa Coffee doesn’t make a dent in Coca-Cola’s $191 billion valuation but it is one of its most significant acquisitions. Although Coca-Cola can often be considered as a self-propelling behemoth, the company has been losing its fizz over recent years and its prospects have been going flat. People are losing their taste for cans of sugary carbonated drinks like the core Coke brand that has been at the heart of the business throughout its 126-year history, with overall revenue having declined for five straight years.
The company has had to remind itself that its skills lie in designing and marketing beverages, not distributing them, after offloading most of its bottling operations in recent years.
Coca-Cola looks to address pressure on sugar
The transition to healthier lifestyles and a hardening stance on obesity by governments around the world has led to declining demand for Coca-Cola’s sugary drinks, prompting the company to acquire a slew of alternative drink brands that offer healthier choices to consumers. The diversity of Coca-Cola’s 500 brands has grown as a result, and now spans the likes of Minute Maid orange juices, Powerade sports drinks, AdeS soy-based drinks, Innocent smoothies and Smartwater.
Read more about the UK soft drinks levy and the impact of the 2018 ‘sugar tax’
Costa has already been lowering the sugar content of its products under Whitbread’s management, with sugar in all its drinks to be reduced by one-quarter by 2020 relative to the end of 2015, with sugar in syrup and deserts also being cut.
Coca-Cola buys Costa to add final piece of the jigsaw
Coca-Cola’s ambitions to become a ‘total beverage company’, however, were being held back by a lack of hot beverages, which Quincey admits is ‘one of the few remaining segments where Coca-Cola does not have a global brand’.
Costa, therefore, has a big job to do. Some shareholders may have felt like Costa has been held back by Whitbread over the years, particularly on the international stage, but now the business must act as a springboard for one of the world’s most recognised brands to enter a huge and highly competitive market.
How much is the coffee market worth?
The global coffee market is estimated to be worth between $80 billion-$100 billion. According to Statista, the US is by far the biggest market in the world, with consumers spending $12.5 billion on coffee in 2017, nearly 50% larger than the next biggest market.
World’s top 20 largest coffee markets
Estimates from Mordor Intelligence suggest the global coffee industry will grow at a compound annual growth rate (CAGR) of 5.5% over 2018 to 2023, with ‘millennials’ (18-36 year olds) to continue driving growth.
Interestingly, the rapid evolvement of the developing world is changing the balance of the coffee industry, among many other agricultural and commodity markets. Most of the world’s biggest consumers of coffee are developed nations while supply almost exclusively comes from the developing world, like Colombia and Vietnam. However, these countries are increasingly consuming their own production as the economy develops and new cultures and classes emerge. This is demonstrated by Brazil, the biggest coffee producer in the world and the second largest consumer (by revenue) in the world. Mordor Intelligence predicts that China, Panama, Kenya and Senegal offer notable potential for the industry over the next five years.
M&A in the coffee market heats up with entry of Coca-Cola
Although the coffee market has long-established players that have cemented their brands it is still highly fragmented, with small, independent coffee shops thriving despite the emergence of Costa and others. Coca-Cola is not the only giant to have made its entry into the sector with Nestle, the owner of instant brands like Nespresso, having splashed out $425 million for a majority stake in US-based Blue Bottle Coffee last year and struck a $7 billion deal to sell Starbucks coffee in retail outlets, including Starbucks ‘pods’ that people use with their coffee machines at home.
JAB Holdings – the private equity giant backed by the Reimann family – has been buying coffee and other hot beverage companies for years, including Peet’s Coffee & Tea in 2012 for an estimated £1 billion, Caribou Coffee in 2013 for $340 million, Nordic Coffee in 2015 for $300 million and Krispy Kreme in 2016 for $1.4 billion. But at the top of JAB’s extensive portfolio is Jacobs Douwe Egberts (which also owns brands like Kenco, Tassimo and L’OR), which generates over €5 billion in annual revenue. Jacobs Douwe Egberts was formed when JAB merged its coffee division with that of Mondelez International in 2015.
Coca-Cola has already hinted at one way it may accelerate the international expansion of Costa by focusing on selling coffee for use in the home, such as pods or instant coffee like many of Nestle’s brands. The ultimate goal for Coca-Cola is the US market, but it is expected that home coffee and Costa Express vending machines would be used for an initial entry before launching any full blown assault on Starbucks’ home turf.
What does the future hold for Whitbread without Costa?
Whitbread has served its shareholders well and while the immediate reaction has been positive amid a promise to splay investors with cash, it will still have to convince the market that its investment case over the longer term is still as compelling without Costa.
The hotel business has been reliable and steady, delivering consistent growth in revenue and profit over recent years. The backbone of this success has been its outright ownership of the majority of its property portfolio. This has not only helped provide stability by giving Whitbread more control over its estate while other retailers and businesses have succumbed to rising rents but also provided it with a financial edge, securing cheaper funding compared to leasing.
Whitbread’s hotel and restaurant business: five-year financial performance
(*Info unavailable after Whitbread merged its hotels and restaurants business)
Whitbread to continue leading UK hotels with Premier Inn
Following the sale of Costa, Whitbread will be entirely focused on its hotels business. It currently has over 75,000 rooms in over 800 hotels in the UK, mostly Premier Inn, the leading hotel brand in the country, in addition to a 49% stake in London-based Pure, which has 15 quick, healthy-eating restaurants.
The business still holds a USP. Whitbread’s combination of hotels and restaurants has been fundamental in the success of Premier Inn and its other brands, with over half of all its UK hotels situated alongside one of its many restaurants. It introduced a new concept in October 2017 to create a pub-restaurant operation that offers quality food in a casual manner at pub prices. Branded as the Cookhouse & Pub, the new concept joins more established chains such as Beefeater, Bar+Block, Brewers Fayre, Table Table and Whitbread Inns.
Whitbread has been cementing its market leadership in the UK by rapidly opening new outlets while expanding and refurbishing existing ones. In the three years to March 2018 the company added 13,842 new rooms to its portfolio, far surpassing the 3545 opened by Travelodge, 1392 opened by Holiday Inn Express and the 562 opened by Ibis. And nearly nine in every ten rooms has been refurbished to its latest format after Whitbread rolled out a new model that allowed it to cut refurbishment costs by almost one-third.
The UK hotel industry is still highly fragmented, with half of the market made up of small, independent businesses. However, the major players and chains have been stealing about 1% from independent hotels each year. Premier Inn expects to take its market share to over 12% by the end of 2020 from 9% in 2016.
This will be achieved by its continued expansion, with nearly 15,000 new rooms in the pipeline set to take Premier Inn's total room count to 85,000 by 2020, with a view of hitting the 100,000 mark not too long thereafter. Four out of ten of the new rooms will be opened in areas where Premier Inn currently has no presence, with the remaining six being evenly split between regions where it has a limited footprint and city centres, like London. This includes ‘hub by Premier Inn’, which are compact city centre hotels, with the firm aiming for 3000 hub rooms by 2020. It also comprises 1000 new Premier Inn rooms in coastal towns, with the company announcing it had signed deals for 400 new rooms last year, with plans to build 500 new rooms and add a further 100 through extending existing sites.
Investment has tapered off over the past couple of years, coinciding with the rise and fall of debt, and its efforts seem to be paying off after profit growth started to outpace revenue last year, while occupancy levels have remained above 80% despite the 25% expansion to its estate over the last three years. This has been partly aided by its effective investment in tech, with 95% of all bookings made directly through the company, driven by its improved app. Still, investors are cautious of the severe slowdown in sales growth over the past two years.
Whitbread looks to replicate Premier Inn success in Germany
With Costa out of the picture Whitbread will have to drive home its message about where its new future lies. While the ongoing progress in the UK will be welcome Whitbread should have the resources and freedom it needs to deliver its next big stage of expansion.
Germany is where Whitbread eyes success, aiming to replicate the success of Premier Inn in a country which has an even more fragmented hotel market than the UK and ‘no clear market leader’. The company estimates independent hotels own up to three-quarters of the entire market in Germany, stating the largest hotel operator in the country holds just 2%.
The plans for Germany are not new, but may well be accelerated as it can fully concentrate on Premier Inn from now on. The first Premier Inn in Germany was opened in 2016 in Frankfurt. It took a major step earlier this year when it bought 19 hotels from Foremost Hospitality Group for an undisclosed sum. That deal took its pipeline for Germany to 31 hotels with over 5700 rooms spread across 15 cities – all of which it expects to be up and running by the end of 2020. It will use its existing strategy of purchasing freehold property to give it an edge, but will also consider leaseholds and purchasing small independent hotel chains. All of its hotels in the pipeline will be rebranded as Premier Inn over the coming years.
Whitbread outlook for 2019: up to 4500 new rooms to be opened
Its overall plans for the current financial year running to March 2019, outlined before revealing the Costa sale, will see the company open between 4000 to 4500 new rooms in both countries, with at least three hotels being opened in Germany.
Whitbread has said it will treat Costa as an asset for sale and a discontinued operation until the deal has been completed. This will start when it releases its interim results for the six months to the end of August, which will be released on 23 October.
Investors will have to wait longer for more details on Whitbread’s overall strategy after the Costa deal, with the business stating it will provide an update on its future plans and the progress made with the Costa sale during a capital markets day ‘early in 2019’. Shareholders will however be hoping for some more details on the outlook for the hotels business in the next set of results.
Could Whitbread become a takeover target?
All three businesses involved look to benefit from the deal and for now it looks like a winner for everyone. Whitbread can draw a line with those disgruntled shareholders that have been waiting patiently for it to separate Costa, sweetening them with what is likely to be a substantial return to investors. The coffee chain gets the financial backing it needs to compete globally and Coca-Cola secures a major brand that completes its portfolio of beverages and provides a platform on which to start building international growth.
However, there is a whiff of caution in the air for Whitbread shareholders. Without Costa providing it with substantial diversification outside of its core hotels business, Whitbread could become vulnerable to being swallowed up by larger hotel players – particularly European chains that may want to snap up Premier Inn’s leading position in the UK and takeover its expansion plans in Germany and further afield. This could draw attention from the likes of InterContinental Hotels Group, Marriott or Accor.
Additionally, Whitbread’s substantial property interests also widens the potential field of interested parties, possibly prodding property investors to make their own bids or, more likely, team up with a large hotel chain.