Sold out: fast-food chains Greggs (LSE:GRG) and Ibersol (LIS:IBS)

Restaurants are not great investments. Restaurant chains need a lot of staff, kitchen equipment and retail space for every new outlet. It is not the kind of business that gets easier as it gets bigger. This makes growth expensive. You can see that in the ROI results of restaurants, which are relatively low compared to sectors such as healthcare and consumer staples. 

Greggs PLC is a British chain that sells bakery products, such as sausage rolls, baguettes, wraps and toast. You typically buy those with a drink for on-the-go, but many Greggs outlets will also have a few chairs and tables for dine-in. The products are affordable for any budget. Like all restaurants, Greggs suffered from the covid lockdowns. I bought the share in 2022 and got lucky that the lockdowns ended soon after my buy. The share price went up quickly, so I did not even have the chance to top it up to a full holding. 

Selling Greggs now could be a big mistake. The brand is a cult hit within the UK. There is some speculation about expanding the brand to other countries. I could see that becoming successful. On the other hand, restaurants often fail when moving into new markets. There may be cultural differences, making the concept unattractive to locals. Existing dining concepts could also have saturated the market already. After considering all this, I decided to sell Greggs. I am trying to free up cash for investments in my main focus area, consumer staples. I am also reducing the amount of holdings in my portfolio. 

Both reasons also apply to my selling of Grupo Ibersol SGPS SA (LIS:IBS). Ibersol runs fast-food and casual restaurants such as Pizza Hut, KFC, Taco Bell, Pasta Caffe, Pans & Company and Ribs within Portugal, Spain and Angola (two KFC outlets). For the first three formulas, Ibersol is a franchisee of Yum! Brands. The latter three are its own brands.

Like Greggs, Ibersol got into trouble due to the Covid lockdowns. It had to issue new shares and sell its Burger King division with 158 restaurants. When the lockdowns ended, Ibersol appeared to have overreached with these actions and had a huge cash balance. I bought the share at 7.00 euros, with Ibersol holding 5.58 euros per share in cash on the balance sheet. It is now using this for share buybacks. It also plans to open 70 Pret-a-Mangers, where they will sell, tasty but expensive, sandwiches and coffee on-the-go. Ibersol obtained the Pret-a-Manger franchisee rights for Spain and Portugal. There are a few finance bloggers who tell the whole Ibersol story much better than me: Carsten Mueller, Gonçalo Garcia, Corner of Berkshire and Fairfax Forum (pay-wall).

So far, Ibersol's expansion plans and buybacks have not impacted the share price much. I lost my patience and sold out of Ibersol again. Like Greggs, selling could prove to be a big mistake. Ibersol seems to be a deep-value opportunity. However, I am dedicated to reorganizing my portfolio around consumer staples. In addition, Portugal has a 25% withholding tax on dividends, which I can not claim back. This makes it somewhat painful to hold Portuguese shares in the long run. Now, admittedly, Ibersol does not pay out much dividends. It prefers to retain earnings for investments in expansion. This, however, raises another issue. Your investment is stuck within the company and you have to hope for Mr Market bidding up the share price to reflect Ibersol's growth. Unfortunately, Ibersol does not grow as fast as tech or AI and the Portuguese market does not have the attention of many investors. 

Ibersol's ROIC is usually around 7%, which can drop quickly to 3% in slow years. Like many restaurant chains, the business is stable, but profitability is also limited. Perhaps that is why Warren Buffett never invested in restaurants, except for Dairy Queen. Still, DQ only runs a limited amount of outlets. Its main role is as the franchisor of the brand. 

Talking about super-investors, let me conclude with some remarks made by Li Lu about the restaurant business in general. He talks about another risk threatening the restaurant business: obsolescence. Although dining trends may not affect Greggs and Ibersol that quickly, it is still a concern for long-term investment.

Can you please tell us what are the most important sources of a company’s moat? Is it a brand, the management team or its business model? What types of moat do you value most?

Li Lu: This all depends on your investment horizon. The longer your investment horizon, the more important industry dynamics become for protecting your moat. The shorter your investment horizon, the more important people become.

The source of each industry and each company’s competitive advantage will be different, as will the degree to which they can protect their moat. We hold ourselves to the same standards and use the same analytical methods when looking at each industry. However, after spending much time on our research, we ultimately reached the conclusion that most companies are too hard and predictions about them cannot be made. The changes in many companies themselves do not make for sustainable competitiveness. Take the simplest example, restaurants. At any time, there will always be a group of restaurants in Beijing with the best business. And some cuisine will always be the most popular. However, you will see that after not too long, these will change. Because even though they’re doing well now, it’s hard to guarantee that they will still be in the future. You can spend a lot of time on industries like this and ultimately realise the same thing: they are too hard to predict.

https://www.longriverinv.com/thought/qampa-with-li-lu

(Li Lu, Himalaya Capital, Speech: "The Practice of Value Investing”, November 2019, Peking University Guanghua School of Management.)

Disclosure: Sold Greggs PLC and Grupo Ibersol SGPS SA. Currently no positions in any of the companies mentioned.

My position sizing system

• 5% initial position for a company incorporated in a developed market
• 2% initial position for a company incorporated in an emerging market

My old position sizing system was a two percent initial buy plus an additional two percent later for companies incorporated in a developed market. I usually did this second buy after a few months of holding the first portion. The purpose of this lag was to get comfortable with the company in the meantime. Sometimes, I did not get such comfort and sold the share. Similarly, I bought half percent positions plus a half percent later on in emerging market companies. It was a careful start because I started a whole new portfolio. However, I ended up holding 75 shares. There is no way to follow 75 companies as a part-time private investor. 

There is a lot of research addressing the proper diversification of a stock portfolio. I believe the picture below illustrates somewhat of a consensus conclusion.

We can see that a portfolio with only one stock results in a huge standard deviation of its annual returns. Adding one stock reduces this standard deviation considerably. Assuming that the added stocks are equally weighted, the variability of the total portfolio goes down as we add more stocks. At some point, let's say at 25 stocks where the arrow is placed in the graph, adding stocks does not reduce variability in any significant way. 

The graph is compiled by looking at a large number of portfolios. We are looking at reality, not a theory. Nevertheless, this perspective on diversification is debated. Many value investors argue that variability does not represent risk; only permanent loss of capital does. The number of shares does not matter either, but rather how confident you are about the business prospects of the underlying companies after intense research. Charlie Munger was not afraid to hold only three shares. However, I do not have the quality of information, insight, experience, and advisors that Charlie Munger had access to. For now, I will go with the traditional concept of risk as expressed by the diversification graph above. 

In any case, I was severely over-diversified, holding 75 shares. It will be nearly impossible to beat an index fund with so many shares. I already experienced that a very successful 0.5% position, such as my triple return with Luckin Coffee, will barely affect my overall portfolio performance. I concluded that my 1% positions in emerging markets China, Thailand, Malaysia and Indonesia did not make sense. I decided to take 5% positions in Malaysian companies from now on. For China, Thailand, Indonesia, and other emerging markets I will allocate 2% per company. That is still a small allocation, but I currently do not have the confidence to take a 5% position per company in these markets.

The reorganization

After deciding on my new position sizing rules, it was time to take action. I sold off a bunch of shares where I did not have the conviction to top them up to 5% or to 2% for a range of different reasons. This was a useful exercise in itself. I increased the allocations of all the remaining holdings, except for Greggs, ABF, Reckitt and Haleon, which already got too expensive. In the case of turn-around situation LG H&H, I want to wait for the Q4 2023 results. With the reorganization mostly done, I own 25 shares now. 

Further concentration?

Looking at the chart above, I could reduce my 25 positions further to 10 positions. The variability of the portfolio as a whole would not increase that much. I could start with taking 5% positions to 10% where I feel confident that a company is extremely undervalued, such as Boustead Singapore and Ibersol. However, from my past experiences as an investor, I have learned that my ex-ante level of confidence is often misplaced and irrelevant. There is no correlation between my level of confidence in a share pick and the subsequent performance of that share. 

As an example, my current best performers are Exotic Food PCL, Tianjin Pharmaceutical Da Ren Tang Group Corp Ltd and Associated British Foods PLC. I would never have guessed these picks as being my winners two years ago. I would probably have guessed Alibaba or Tencent then. Without a mechanical allocation system, I would have doubled down on these two stocks. This doubling-down behaviour is known as Get‐Evenitis or, more officially, loss-aversion bias. A mechanical sizing system is an antidote to this bias. It saved me from a bigger disaster in the Chinese tech space. 

Hence, I will stick to my mechanical allocation system. Should I ever change the current 5% and 2% sizing numbers, it will be wise to apply the new rules to all my shares, not to a selection.  

Disclosure: long position in all the shares mentioned, except Alibaba, Tencent, Tianjin Pharmaceutical Da Ren Tang Group Corp Ltd and Luckin Coffee, which I sold off

Coffee in my portfolio

I named my investment approach the Coffee Can Portfolio APAC after a buy-and-hold method developed by American analyst Rob Kirby. I tweaked the approach he suggested by focusing on infrastructure and consumer staples stocks. As a result, I have a bunch of coffee-related companies in my portfolio. I thought it would be fun to highlight those.

JDE Peet's is the unmistakable coffee king in my portfolio. The company offers many coffee brands all over the world: Peet's Coffee, Jacobs, Douwe Egberts, Campos, Tassimo, Senseo, L'OR, Super (Singapore), Old Town White Coffee (Malaysia), and tens of other brands. Some of those have cafe-type outlets which you can visit. The picture shows a pop-up store of Peet's Coffee in Shanghai.

Luckin Coffee is a Chinese coffee giant which runs cafes but has no packaged product yet. In some of their outlets, you can sit down to enjoy your coffee, but most are takeaway only. They have more stores than Starbucks in China, but in revenue, Luckin is still second because their products are cheaper.

Maxim's Caterers is a 50% participation of my holding DFI (Dairy Farm International). Maxim's has the license to exclusively run Starbucks stores in Singapore, Hong Kong, Macau, Vietnam, and Cambodia.

Maxim's Caterers has a joint venture with Fraser & Neave, another holding of mine, to run Starbucks stores in Thailand. This joint venture is also 50/50.

Staying with Dairy Farm International, its house brand Meadows offers instant coffee and 3-in-1 coffee mix in their supermarkets, such as Giant and Cold Storage as well as in third-party outlets (Foodpanda).

South-Korean consumer goods conglomerate LG H&H runs a beverage bottling operation that produces drinks from the Coca-Cola Company. The canned coffee brand GEORGIA is one of the Coca-Cola drinks they licensed for Korea. 

China Foods Limited is licensed to sell Coca-Cola beverages in 19 provinces of China. They don't offer GEORGIA, but they do have another canned coffee drink in their portfolio called Costa RTD coffee. Costa is a coffee shop chain acquired by the Coca-Cola Company in 2019. There are Costa coffee shops in China too, but it seems that China Foods is not involved in those. 

The strangest coffee drink from my holdings comes from Want Want China: Mr. Bond Coffee. I could not find any information about it. Are they referring to James Bond? The man shown on the can resembles detective Sherlock Holmes rather than master spy James Bond. Also, I am pretty sure Bond prefers Martini over coffee.

For the final two coffee servings, we leave Asia. British bakery chain Greggs sells coffee to go with their sausage rolls and sandwiches. Classics such as Mocha, Americano, and Latte, with special editions during holidays. Recently they added two canned coffee offerings: Caramel Latte and Original Latte, as the picture shows.

Associated British Foods offers various grocery items all over the world. In their long listing of those, I found Jarrah, which is an Australian brand of powdered coffee. You pour hot water over the powder to make it ready for consumption. Jarrah offers a hot chocolate variant too.