Whitbread Stock Purchase (LON:WTB) – A Gauge For Global Prosperity

With a collection of hotels, restaurants and coffee chains under it is portfolio, it is easy to see why Whitbread is benefiting from the trend of increasing consumer prosperity. The theory is this, as people get richer, they want to indulge in products offered by the services industry. This means spending more money on travel (hotel accommodation) and eating out. Whitbread has been perfectly placed to capture this megatrend over the past few years and with an international pipeline that is only set to increase, the company is set to reap the rewards of increasing global prosperity.

The natural fear for investors when investing in firms that capture the more cyclical areas of the consumer market, like eating out and travel, is what will happen during the next downturn. What will happen when a recession comes along. Surely people will reduce on travel and eating out when the economy is gloomy. This ideology indeed holds true. During the great recession of 2008-2009, consumer spending in western economies dropped sharply and this hit profits and share prices of companies across the consumer discretionary sector. But the one food sector that surprisingly stood up really well during this time was coffee. I say it is surprising because you would think ready to go coffee would be one of the first items to go when budgets are squeezed.

Another thing to note is that when a recession hots the economy, people don’t stop travelling, they instead go for cheaper options. This means they would stay in cheaper hotels and this is great for Whitbread’s Premier Inn. Another thing is that Brits will more likely stay within the country rather than go abroad during a downturn and this is another great boon for Premier Inn. In short, the Premier Inn brand, which contributed over 50% of Whitbreads profit last year will hold up better than most hotel chains in the case of a recession. This brings about a certain margin of safety in the business operations.

Coffee: Addictive Products Are Great For Investors.

The main reason for me investing in Whitbread is to get exposure to Costa Coffee. Whitbread bought Costa in 1995 and is now a 100% owned subsidiary. In hindsight, this has proved to be a great move as their has been a tremendous increase in the coffee drinking culture over the past few years and the returns produced by coffee companies are exceptional.

As mentioned above, consumers did not totally cut down on their coffee habit during the last recession. Companies like Starbucks and Costa actually reported increased profits during the past financial crises. It seems that coffee is much more addictive than people would like to think. It seems that coffee has become a staple of sorts much like cigarettes.

When you have an addictive product that is cheap to make and has high operating margins, you know you are on to a winner. Just look at how well tobacco companies have done over the past decade. A simple £1,000 investment in Phillip Morris would have been worth £8,500,000 just 50 years down the line. How amazing is that! This is all down to cigarettes being in demand throughout the economic cycle as well as them having high returns on equity.

If coffee goes the same way, or even does half as well, investors in coffee companies will be laughing all the way to the bank. There are already signs of this happening. Just look at how Starbucks (SBUX) and Tim Hortons (THI) have done over the years.

Costa has excellent revenue and earnings growth metrics: Over the past ten years, revenues have grown by 15% annually. For every Pound (£) that Costa retains for itself (e.g. doesn’t pay in dividends to Whitbread), it earns returns of 49.9%. This is simply crazy! It is the reason why profits are going through the roof—it is able to benefit from lower coffee prices while simultaneously charging more for coffee products each year.

Buying Costa and Getting the Hotel and Restaurant Chains For Free

With Costa’s rapid growth, there are mutterings in the city that Whitbread will spin-off Costa into a stand alone entity. Whilst I don’t think this will happen anytime soon, a spin-off will definitely unlock value for shareholders.

With Costa’s only like for like competitor, Starbucks, trading at 30x profits,a spin-off today will likely lead to the new company having a market cap of £4.5 billion. Whitbread today has a market cap of £6.5 billion. This means that excluding Costa, the rest of Whitbread, the hotels and restaurants are worth £2billion. The hotels and restaurants business made £446 million last year. This means that investors are currently valuing the hotels and restaurants at a very low 4x profits.

The current price of Whitbread suggests that you pay full price for Costa Coffee, but you get the hotels and restaurants for free. This is a deal I will take any day of the week.

My Purchase of Whitbread (WTB)

I recently bought 30 shares of Whitbread at 3500 a share. Combining this which my previous purchase brings my total holding in WTB to 34 shares.

Whitbread currently pays 90p a share in dividends a year so my 34 are expected to bring in £31 annually. Whilst a yield of 2.5% does not sound like a lot, the company has been growing its dividend at 10% over the past few years. So whilst I only get £31 in my 2017 , I am expecting to get £34.1 in 2018, £37.5 in 2019, £41.25 in 2020 and £45.4 in 2021. All of a sudden, a low starting yield of 2.5% does not sound so little. This is the power of dividend growth. This is the power of time in the market. As a famous investor once said, time is the friend of an investor.