Despite a 60% rally in 2023, shares in this very well-known business are still less than half their value in 2019. Analyst Edmond Jackson decides whether to order a stake.
Among enticing charts currently is mid-cap pub chain JD Wetherspoon (LSE:JDW), appearing as if a spring is uncoiling.
Covid and inflation knocked the share price down from an end-2019 high of 1,600p to 390p last October. Wetherspoon had firstly to cope with lockdowns, then growth stock ratings were impacted, and last year energy/input prices soared.
Since the low, it has risen 86% to 725p, especially in the last month or so after chair Tim Martin bought nearly £12 million worth of equity at 457p on 1 February.
His trading has been broadly astute: last selling over £50 million worth at 1,150p in January 2021, which trimmed his stake from 25% to 22%. This was said, however, to meet “significant buying interest” after a £94 million placing at 1,120p - to see the group through an anticipated low sales period after re-opening, also make acquisitions.
A 13% spike to 660p following the 24 March interim results has been extended this week, implying that expectations are rising. Are they right?
A more demanding valuation despite big de-rating
While the share’s de-rating of the last two years took the price back to levels a decade or so ago, there has been dilution along the way – although a total 129 million shares now in issue is not huge.
For context, I was positive at 415p in November 2010 – on a forward price/earnings (PE) ratio of 11 times based on expectations of £79 million pre-tax profit in Wetherspoon’s July 2012 year. In the wake of the global financial crisis, I thought Wetherspoon was well-placed – adding breakfasts to its good value food-and-drink range. Manifestly, its formula worked well.
By September 2019 at 1,550p, and in June 2020 at 1,180p, I adopted “sell” stances based on high valuation and debt levels – even suggesting in June that an experienced trader might consider a short position say by way of a contract for difference or spread bet.
(At the time, it was interesting to consider ways to hedge an equities portfolio for the risk of disruption from another viral wave.)
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At 1,550p, the stock traded at 20 times expected earnings, five times net asset value and a yield under 1% - the dividend being suspended during Covid lockdowns.
At 725p today, the shares trades on 35 times consensus earnings per share (EPS) of near 21p for the financial year to 31 July, easing to near 24 times based on expected EPS of just over 30p next year. Interim EPS measures are all over the shop: only 1p before £65 million interest rate swap income, albeit 29p after this and other items.
A 4.5p dividend projected for 2024 would be a negligible yield, but at least 2.2 times net asset value is not so extended like in 2019. The balance sheet has around £1.8 billion of fixed or right-of-use assets, although pub valuations seem tricky as plenty have shut down across the UK. Might some sites be overvalued while others that are well-placed be valued lowly at historic cost?
J D Wetherspoon - financial summary
Year end 31 Jul
|Turnover (£ million)||1,595||1,661||1,694||1,819||1,262||773||1,740|
|Net profit (£ million)||51.2||56.6||66.7||72.8||-97.6||-126||30.6|
|Operating margin (%)||6.7||7.2||7.2||6.9||-3.2||-16.3||1.8|
|Reported earnings/share (p)||43.4||50.8||63.2||69.0||-91.6||-144||15.2|
|Normalised earnings/share (p)||48.3||80.1||81.7||75.9||-153||-289||17.7|
|Operational cashflow/share (p)||111||159||167||165||15.7||-28.7||94.1|
|Capital expenditure/share (p)||28.4||52.6||65.3||51.5||41.6||18.2||36.2|
|Free cashflow/share (p)||82.6||107||102||113||-25.8||-46.9||57.9|
|Dividend per share (p)||12.0||12.0||12.0||12.0||0.0||0.0||0.0|
|Covered by earnings (x)||3.6||4.2||5.3||5.8||0.0||0.0||0.0|
|Return on total capital (%)||10.2||11.0||10.6||10.5||-2.1||-7.5||1.8|
|Net debt (£m)||651||696||726||737||1,390||1,369||1,365|
|Net assets (£m)||207||258||287||317||317||278||322.0|
|Net assets per share (p)||183||237||272||301||264||216||250|
Source: historic company REFS and company accounts
Cash flow valuation is better but cocktail of costs ahead
It could be unfair to focus on the PE given earnings can vary on annual sales of twice market value. Also, Wetherspoon’s cash flow profile is stronger than earnings, and the stock currently trades on 12.5 times free cash flow in the last financial year. The interim 2023 cash flow statement shows an exceptional £169 million boost from termination of interest rate swaps.
But mind how UK inflation and interest rates will affect costs. In Wetherspoon’s first half-year, operating costs rose 9% to £873 million – chiefly energy, food and labour. Its energy price hedge expires at end-July and the interim results show £34 million of finance costs taking 90% of operating profit, then being “rescued” by £65 million income relating to the interest rate swaps.
The 29 January balance sheet had £794 million debt, predominantly long term, and £454 million of lease liabilities relative to £46.5 million cash. It meant net debt as a proportion of equity was 195%, or 313% including leases. The group would therefore be challenged by a stagflation scenario with interest rates rising.
Not surprisingly to trim costs, 35 pubs were put up for sale in January relative to a circa 800 pub estate. I was quite surprised to see this included one in Sevenoaks high street, which has appeared to serve a role versus pricier pubs.
Pub equity valuation parameters vary
Mitchells & Butlers (LSE:MAB), the near £1 billion owner of outlets such as Harvester and Toby Carvery, trades on a forward PE near 13 times and an historic price/cash flow multiple over 8, but has not paid dividends since 2017.
Young & Co's (LSE:YNGA) is a bit of a special situation: like Wetherspoon a quite high PE around 17 times versus 12 times free cash flow, but there is also a 2% yield and 16% discount to net assets.
I recall how despite the 2009 recession, Young’s proved a stock market winner, largely because affluent professionals in southern England did not compromise on going out.
Wetherspoon’s relatively higher overall valuation metrics imply a radical change in view: from fears its older-age and lower-income customer base would resort to supermarket-bought alcohol at home, instead to Wetherspoon benefiting from trading down from other pubs.
Does Wetherspoon have a timely marketing formula?
Anecdotal evidence suggests busy trading in many of Wetherspoon pubs at weekends, given a round of drinks may cost roughly half the prices elsewhere.
Taking share is also implied by Wetherspoon’s trade volumes in the seven weeks to 24 March, up 9% on the same period in the 2019 year (pre-Covid) and 15% up on 2022.
Tim Martin says he is cautiously optimistic about 2023 and “years ahead.”
I share his outlook based on Wetherspoon’s marketing pitch being attuned to straightened times, given the English tendency is to keep going out. The group’s hotels could also benefit from trading down, although they constitute just 1.3% of group revenue.
I am, however, cautious about debt service and other costs given I question UK authorities’ predictions for inflation to fall sharply this year.
Sporadic short interest
Short positions in Wetherspoon shares reflects conflicting views lately, both on valuation and the underlying commercial story.
Back in 2016, a peak 6.0% of the issued share capital was out on loan (as measured by individual short trades over 0.5%). This fell to zero by early 2020 then rose again in early 2022, peaking at 3.5% this last January. The overall pattern is broadly astute and did drop to 1.3% by 1 March, now edging up again as two hedge funds short further.
At just over the 0.5% threshold is Citadel Advisers, while Systematica Investments trimmed its position 0.1% to 0.8% on 14 February. Franklin Templeton, however, raised its short nearly 0.1% to over 0.6% as of 23 March, not looking very clever given the stock then rose nearly 14%. Qube last increased 0.02% to over 0.6% on 28 March.
Based on the Altman Z-Score indicator of financial risk, Wetherspoon remains a candidate for short selling. Yet on 21 February, a non-executive director bought £29,300 worth of shares at 533p.
Reflects your own risk appetite
Since I am wary of a stagflation scenario, with the Bank of England in a real dilemma on further interest rate rises, I would not be prepared to chase rising hopes at a stock with sizeable debts.
Yet my caution could be overdone, and the economy might give Wetherspoon what it needs to outperform – or at least take share, then benefit into an upturn. Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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