Holding its nerve as the pandemic choked occupancy rates and ploughing more cash into expanding the number of hotel rooms on its books proved a shrewd move for Whitbread. The owner of Premier Inn is hoping to repeat that trick in the face of the latest economic storm.
A long-term target to expand the core British Premier Inn business to 110,000 rooms has been lifted to 125,000, from a present estate of just under 83,000. Half-year profits 15 per cent higher than the pre-pandemic level and way ahead of market consensus show the rewards that can be derived from capitalising on supply leaving the market.
Increasing the number of Premier Inns helped to boost the top line, as did higher occupancy — but pricier room rates have proven a far greater filip, with the revenue generated per available room over the six months to the start of September 27 per cent higher than the same time in 2019.
Squeezed independent operators are leaving the market, a trend that could well continue over the next 18 months. Premier Inn has the balance sheet strength and benefits of scale to better withstand the pressure bearing down on consumers’ and corporate spending.
The risk of demand slowing more dramatically, which in turn would drive a fall in rates, is the chief challenge if Whitbread is to achieve profit expectations for this year and the next. Investing an extra £60 million in marketing, IT and wage and energy bill inflation will result in lower margins during the second half of the year.
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Adjusted profits of £261 million for the first half are within £34 million of recently increased full-year market consensus, which means upgrades to analysts’ forecasts for this financial year are a given. Shore Capital raised its pre-tax profit figure to £320 million, which assumes that growth in revenue per available room slows to 10 per cent during the second half from a rate of more than 100 per cent during the previous six months as the company laps severe restrictions in Germany.
The shares have drifted 16 per cent lower since the start of this year and are even further below their pre-pandemic level. On the surface, they still do not look too cheap, at roughly 19 times forward earnings, but strip out the losses generated by expansion in Germany and the company’s market valuation looks more compelling. Whitbread has opened 42 hotels in Germany and has a further 38 in the pipeline. Extract the £1 billion earmarked for investment in the German business and the losses accumulated in that market and the shares trade at about 14 times forward earnings, Shore Capital calculates.
That assessment makes sense only if the fledgling German business returns at least the amount invested in it. A target to break even on the hotels already open by 2024 is one litmus test of whether Whitbread’s expansion on the Continent might pay off. Hotels opened for at least a year turned profitable for the first time during the second quarter. The losses incurred by the German business are expected to be between £40 million and £50 million this year, £10 million lower than previously anticipated.
Shore reckons the entire German business will hit profitability in 2025 as the proportion of hotels open for more than 12 months increases. The caveat is whether the successor to Alison Brittain, the outgoing boss, accelerates the pace of hotel openings, which would sap more cash in exchange for potentially bigger gains down the line.
Whitbread’s appeal as a takeover candidate is undimmed. Of its vast hotel estate, 55 per cent is freehold, which provides ample room for the sale and leaseback of its properties. Net cash on the balance sheet has grown to £182 million and its defined-benefit pension scheme has a net surplus of £400 million. Factor in the slump in sterling and an overseas buyer might be tempted to take a tilt at Whitbread.
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ADVICE Buy
WHY Shrinking losses in Germany and takeover potential could help the shares move higher in the medium term
Softcat
Doubts that Softcat can sustain its stellar rates of growth have eroded the software reseller’s premium rating. The shares trade at 21 times forward earnings, hardly budget territory but lower than last year’s peak multiple of 45 and below an average of 25 since its 2015 float.
The return of travel and entertainment costs (which were absent during the pandemic) and wage inflation mean that operating profit is expected to be flat this year compared with last time round, when profits rose by 14 per cent. But indications that companies and public sector clients are pulling back on IT spending amid a darker economic outlook are yet to appear.
Softcat has been growing ahead of the market rate, announcing gross profit growth of just over 18 per cent over the 12 months to the end of July. Taking market share accounts for the bulk of growth, with the remainder generated by selling more products to existing public sector, mid-sized and large corporate clients. The company estimates it has only a 20 per cent to 25 per cent share of customers’ overall IT spending and only a 4 per cent share of what is a highly fragmented market.
It reckons, too, that even if it was forced to write off an extra £5 million in bad debts and to suffer a 7.5 per cent decline in revenue, it would continue to be profitable and would maintain a net cash balance. True to form, the net cash balance stood at £97 million at the end of July, but an increase in the cash floor Softcat seeks to maintain, from £45 million to £60 million, meant a lower special dividend of 12.6p a share was declared. Still, shareholders should be in line for more special returns next year, given analysts’ forecasts of net cash of £107 million at the end of the present financial year, a way above that £60 million benchmark. The shares may flounder in the short term, but longer-term growth prospects remain.
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ADVICE Hold
WHY The shares may struggle to find a catalyst in the near term because of wider economic weakness
