FTSE 250 fast-food retailer Greggs (LSE: GRG) is one of those companies whose share price I find difficult to square with its fundamental worth.
I think many firms in the FTSE 100 and FTSE 250 are undervalued to one degree or another. This is largely down to a broad-based devaluation of British firms following the country’s withdrawal from the European Union, in my view.
The idea behind this was that Great Britain’s gross domestic product (GDP) would grow less than the eurozone’s. This in turn would lead to lower growth in British companies than would occur in those of the single currency area.
However, since 2016’s Brexit decision the eurozone’s average annual GDP growth has been 1.5% and Great Britain’s 1.7%. So much for that theory.
I also think that Greggs suffers from being seen by the market as unfashionable and, yes, unsexy. As a former senior investment bank trader, I know market perception plays a significant part in a stock’s price. And great though many think its steak bakes are, the firm is not seen in the same bracket as Rolls-Royce.
Its 2024 results are a case in point
On 4 March, Greggs released its 2024 results, and the share price dropped 8%. I seriously double-checked to make sure I had indeed seen the right set of figures.
The results started with the headline that total sales broke the milestone £2bn barrier for the first time. They featured an 11.3% year-on-year rise to £2.014bn and an 8.3% pre-tax profit jump to a record £203.9mn. And Greggs opened a record 226 new shops over the year.
The firm added that its 2021 target of doubling sales by 2026 remains on track. I think it worth noting here that it overtook McDonald’s as the UK’s top breakfast takeaway in 2023 and retains that position.
The only possible reasons for the share price drop I could see were comments about weather conditions and inflation.
More specifically, the firm said there were challenging weather conditions in January for sales – perfectly understandable, as this is Britain. And it said it can “manage inflationary headwinds” – inflationary headwinds in the country cannot be news to anyone.
So is it a bargain now?
There is no reason to expect the market’s perception of Greggs to suddenly change in the short term. This remains a key risk for the share price, in my view. Another is a surge in the ongoing cost-of-living crisis that causes customers to reduce food-to-go spending.
However, in my experience a firm’s share price does eventually align closer to its fundamental value over time. And in Greggs’ case, I see a lot of value.
The acid test is how its price looks compared to where it should be based on future cash flow forecasts.
Using other analysts’ numbers and my own, the resultant discounted cash flow analysis shows Greggs is 53% undervalued at £17.95.
Therefore, the fair value for the stock is £38.19, although market perceptions of the stock may keep it lower.
If I were not focused on 7%-yielding stocks, Greggs would be an irresistible bargain for me based on its huge fundamental value. It is only on the basis of its sub-7% yield that I am not buying it.
This post was originally published on Motley Fool
