October 11, 2018 / 2:51 PM / 7 months ago

Breakingviews - Pret’s soured image puts fat returns out of reach

A man browses a sandwich display at a Pret A Manger cafe in London, Britain April 27, 2017. REUTERS/Neil Hall

LONDON (Reuters Breakingviews) - Pret A Manger’s owners are facing lean returns. Two customers died after eating contaminated products from the ubiquitous sandwich chain. That’s bad news for takeover specialist JAB, whose 1.5 billion pound buyout in May derives its force from the scope to expand Pret’s slim margins. The cost of putting things right messes that up. 

Pret’s woes began in September, following an inquest into the death of a 15-year-old customer who died in 2016 after eating a baguette that had not been properly labelled as containing sesame. On Monday, the company confirmed that a second customer had died after eating a supposedly dairy-free product that was not. Although Pret tried to contain the fall-out by promising a new labelling system, UK tabloids have been giving it a kicking. 

Back in May, the outlet was the darling of white collar workers looking for fresh, organic food. Through its 530 outlets, sales increased over 13 percent to 879 million pounds in 2017. Given that growth, it would have been plausible for JAB to expect sales to grow by least 9 percent, around the five-year sector average according to Euromonitor International. 

Add in the scope for Pret’s 11 percent EBITDA margin to double to the level of rival Starbucks and the company’s enterprise value would be 4.5 billion pounds, according to Breakingviews calculations, assuming it could sell the business in five years at the 15 times EBITDA multiple JAB bought in at this year. If it also used 30 percent of operating cash flow to pay down an estimated 500 million pounds of debt, its equity would be 4.2 billion pounds - over four times the initial outlay, representing an annualised internal rate of return of 34 percent. 

That now looks fanciful. Pret’s decision to change its labelling policy will require the chain to either hire new staff or make existing staff work longer shifts. It will have to implement strict quality controls to make sure allergy information is displayed correctly. Hence EBITDA margins could go down, not up. If they fall to 8 percent and rivals like Nestlé muscle in and cut revenue growth to 7 percent, the IRR could be more like 2 percent. That’s more than a bit unappetising.


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