LONDON -- Capital appreciation is surely the goal of many investors. One method of achieving that is to buy companies with steady earnings growth. If bought when the shares are cheap, two drivers could move the share price up:
- Growth in earnings, and
- An upward P/E rerating.
Highly successful fund manager Peter Lynch classified steady growers as stalwarts, which he typically traded for 20% to 50% share-price gains. But whether buying for gains like that or holding for the longer term, we need to know if reliable earnings growth can continue, and whether the shares are cheap.
Seeking durable growth
Not all companies achieve stable growth, as you can see by the aggregate performance of those in London's premier FTSE 100 index (UKX), where the compound annual earnings-growth rate has been just 0.7% over the past five years:
|
Year to June |
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
|---|---|---|---|---|---|---|
| FTSE 100 index | 6,608 | 5,626 | 4,249 | 4,917 | 5,946 | 5,571 |
| Aggregate earnings per share | 537 | 503 | 427 | 397 | 527 | 557 |
Consistent, cash flow-backed growth in profits is a promising characteristic in today's markets, so for this series, I'm examining firms with annual earnings growth between 4% and 20%.
One contender is Whitbread
|
Trading Year |
2007 |
2008 |
2009 |
2010 |
2011 |
|---|---|---|---|---|---|
| Revenue (millions of pounds) | 1,217 | 1,335 | 1,435 | 1,600 | 1,778 |
| Adjusted earnings per share |
79.23 pence |
93.1 pence |
90.53 pence |
111.79 pence |
127.38 pence |
So, earnings have grown at an equivalent 12.6% compound annual growth rate putting Whitbread in the Stalwart category.
If the name Whitbread evokes the idea of breweries and pubs, as it did with me, think again. The company sold most of its beer-and-spirits-related businesses in 2001, refocusing on the growth areas of hotels and restaurants. The firm reckons it employs more than 40,000 people worldwide, serving more than 19 million customers every month.
Despite its several well-established brands, Whitbread uses a simple method to analyze its revenues: Roughly, 70% comes from hotels and restaurants and 30% comes from perky performer Costa. When you consider last year's revenue was about 1,778 million pounds, that looks like a lovely lot of coffee. We are obviously a caffeine-hooked nation. And most of those sales were from Britain, too, as the company derived only around 3% of sales from overseas.
One legacy of such a long and illustrious trading history is the size of the pension deficit, which stands at about 640 million pounds. Regular contributions to that drag on cash flows. Despite flat markets, the directors reckon that earnings growth is still on the cards going forward, driven by the company's ever-strengthening brands.
Whitbread's earnings growth and value score
I analyze five indicators to determine whether earnings growth can continue and if the shares offer good value:
1. Growth: earnings, revenue and cash flow all growing. 4/5
2. Level of debt: net debt is around 2.7 times earnings with net gearing at about 39%. 3/5
3. Outlook and current trading: good recent trading and a cautiously positive outlook. 4/5
4. Enterprise value to free cash flow: a trailing 23 or so, and above growth rates. 2/5
5. Price to earnings: around 18, and above historic growth rates. 2/5
Overall, I score Whitbread 15 out of 25, which encourages me to believe this stalwart can continue earnings growth that outpaces that of the wider FTSE 100. When compared with the FTSE's price-to-earnings ratio of around 11 and the firm's growth predictions, it looks like the market is pricing in growth expectations.
Foolish summary
The business seems to be performing well, generating cash-backed profits, which are helping it to manage its debt load. It scores lower on the valuation measures, which make the shares look a little pricey -- not unlike its delicious coffee, I think.
Right now, forecasted earnings growth is 10% for the 2013 trading year, and the forward P/E ratio is about 14 with the shares at 2,298 pence. Considering that and the other factors analyzed in this article, I think that the firm can stay on watch for the time being.
Whitbread is one of several steady-earnings-growing stalwarts on the London stock exchange, each with the potential to deliver significant capital appreciation when purchased at sensible prices.
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