Whitbread plc’s (LON:WTB) decision to spin off its Costa Coffee chain from the rest of the business makes sense but challenges remain, according to analysts.
The company on Wednesday said Costa would become a separately listed business following a demerger, which is expected to take two years to complete.
READ: Whitbread shares fall as it confirms spin off Costa Coffee after activist investor pressure
The move came after the group received pressure from activist investors, Elliott Advisors and Sachem Head, for Whitbread to be split into two parts - the Costa and the Premier Inn hotel and restaurant chains.
“Coffee shops and hotel rooms don’t make natural bedfellows, so splitting off Costa Coffee from Premier Inn makes sense for Whitbread,” said Laith Khalaf, senior analyst at Hargreaves Lansdown.
“The break-up will provide each of the two emerging companies with greater strategic focus on their own goals, and will allow investors to choose which of the two distinct brands they actually want exposure to.”
Analysts at Numis echoed Khalaf’s remarks, saying it seems “entirely logical to us”.
They said it is possible that “a degree of M&A (merger and acquisition) premium be attached to an independent Costa”.
“In our view equally important will be a return to growth for Costa, if it can re-position the UK estate away from retail locations and towards convenience while continuing the successful roll-out of Costa Express,” Numis added.
High street struggles
However, Whitbread has acknowledged that is facing risks given pressures facing the high street. Consumers have been cutting back on spending as higher inflation cuts into disposable incomes.
Liberum analysts said: “We believe challenges remain - high street conditions remain subdued and pursuing additional cost savings in an inflationary environment whilst simultaneously preparing for a de-merger holds execution risk, hence we remain ‘hold’.”
In 2016 Whitbread announced a five-year efficiency programme to generate £150mln of savings and so far this has delivered £105mln of savings.
Whitbread has 'right long-term strategy'
Liberum raised its target price to 4,450p from 4,150p as it believes Whitbread has the “right long-term strategy” by focusing on its international expansion and developing new channels to market.
Whitbread plans to open 4,000-4,500 Premier Inn rooms in the UK and Germany along with 230-250 net new Costa stores globally in fiscal year 2019.
“Concentrating on Germany for Premier Inn makes huge sense given the market dynamics and under penetration of budget brands there but it takes time and considerable investment,” it said.
“Likewise, diversifying its store locations away from dying high streets toward travel hubs should also improve profits.”
Costa revenues rose 7.5% in fiscal year 2018, driven by growth in its Costa Express self-service coffee bars.
Total revenue rose 6.1% to £3.3bn, including a 5.2% increase at Premier Inn, and underlying pre-tax profit climbed 4.5% to £591mln.
Pension scheme 'needs addressing'
On top of the external challenges facing the company, Whitbread also needs to address its pension scheme and set up a separate board to carry out the spin-off of Costa.
Khalaf reckons the two-year timeline for the split gives the group plenty of time to resolve such matters.
“The split could also ultimately lead to a shake-up of the top brass at Whitbread, unless the executives are willing to accept the reduced earnings potential running a smaller company probably entails,” he added.
The analyst also thinks Elliott and Sachem Head will still try to influence proceedings, particularly in respect of the timing of the split, since two years is longer than they would have wanted for the deal to be completed.
“Indeed the fairly lengthy timeline looks very much like Whitbread’s attempt to maintain control of proceedings. In essence management has agreed to go with the flow, but isn’t relinquishing command of the vessel.”