Stockwatch: should you buy or sell JD Wetherspoon shares?

Can this highly rated pub owner shrug off tighter restrictions and an end to subsidised food and drink? 

The six-month chart for mid-cap pubs operator JD Wetherspoon (LSE:JDW) is showing renewed bias to the downside, helped this week by news that pubs must close at 10pm as authorities clamp down on Covid-19 transmission. 

After a plunge from around 1,500p in late February, the stock had shown an indecisive recovery – breaching 1,200p in late May, then a drift to 830p by early August. This appeared to tally chiefly with macro themes: a recovery in global stocks from late March based on stimulus measures, then “Eat Out to Help Out” from 3 to 31 August. 

Company-specific news, such as a 24 June update about the pubs re-opening from 4 July, has appeared to correlate little with the stock trend. 

Against a still-high rating therefore, a sceptic might say there is more reality check ahead for Wetherspoon shares as central bank stimulus levels off and the UK chancellor steps back from “whatever it takes”. I think he will resort to further government borrowing while the economy remains fragile, and tax rises will come after the next general election (whoever is in power). 

The macro context is therefore mixed for Wetherspoon. Government will seek to ensure people who need financial support get it, and pub goers will have a value-conscious mentality. But the period of direct support measures helping prop the shares is over.  

Richly valued relative to Young’s

Around 775p currently, Wetherspoon trades on over 30x the consensus expectation that earnings per share (EPS) will recover modestly to 25.6p in the financial year to 28 July 2021. This would be after a net loss of £12.4 million in the latest year to July 2020 based on £1.3 billion sales, which is tipped to improve to £29.5 million net profit on £1.5 billion sales in 2021, albeit well down on pre-Covid numbers as shown in the table below.

It is logical, and indeed a market feature, for a stock to trade on a high price/earnings (PE) ratio where confidence in recovery exists, although here it assumes success with a vaccine in due course, not years of limited social contact. 

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By comparison, peer Young’s (LSE:YNGA) trades on around 16 times expectations for it to fully regain pre-Covid earning power in its year to April 2022, after losses in the current year. That may reflect some bias towards Young’s, with the City under-estimating Wetherspoon’s marketing prowess and, that if people become more cautious towards pubs overall, Young’s earnings will be impaired likewise.

When I have examined these groups financially, I have noted Young’s tangible net assets of 954p per share versus Wetherspoon’s of 251p. That currently represents a share price discount of 4% for Young’s versus a premium of 68% for Spoons, and I suggest it is why Young’s shares have started this week down nearly 6% but Wetherspoon’s fall is around 12%.

Dividend forecasts are suspended for both groups.

Some 251% net gearing adds to Wetherspoon’s financial risk, versus 33% for Young’s. Wetherspoon’s 26 January 2020 balance sheet had around £850 million debt, virtually all long-term, relative to £47 million cash and £320 million net assets of which only 4% were intangible. It meant an annual interest charge of £18.5 million which took 24% of operating profit, there being scant interest on cash reserves. This is another reason for the stock falling currently, as debt service costs will weigh on profits compromised for longer by the new social restrictions.  

Potentially, Wetherspoon can mitigate effects of the 10pm curfew with more marketing effort into the venues’ good reputation for all-day meals. More significant I suspect, is whether people become more cautious at eating/drinking out at all, if it puts you at higher risk of being required to self-isolate via Test and Trace if someone at a pub succumbs to Covid-19.  

Maintaining a ‘sell’ stance since last September 

I have taken a balanced view to Wetherspoon over the last decade. In November 2010, I was a fan at 415p on 11 times forward earnings and a buyback programme underway, and I stayed positive while management expanded its good-value food and drink e.g. serving breakfasts.

However, last September I switched to ‘sell’ at around 1,550p which represented around 5x net asset value, a forward PE over 20x and a prospective yield of just 0.8%. There was quite an "event trigger" by way of profits for Wetherspoon’s financial year to 28 July, slightly down as a result of not passing on higher drinks costs to customers.  

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Last 5 June I reiterated ‘sell’ at 1,180p in the expectation a second wave of Covid-19 would bring back restrictions to some degree. The stock fell to about 840p by late July and appeared to put in something of a “double bottom,” which may have been a chart trigger for traders to buy, as the price had rallied to about 1,060p only a fortnight or so ago.

I believe this shows how complacent, stock market traders have become after a period of easy gains. Busy summertime bars and restaurants were always going to boost an inevitable second wave. 

Looking forward, the crux is whether autumn/winter makes people warier of frequenting indoor venues, with Covid-19 again on the rise. It makes financial forecasting quite impossible; a stance on the shares is behavioural judgment. 

Past recessions, indeed only last summer, have shown British people remarkably resilient at patronising pubs. Some of them may be sceptical that our medical bosses are scaremongering, although I suspect a tough winter ahead for hospitality services with a net attrition of clientele. More people will be unwilling to frequent busy interiors even with distancing. 

Where is the positive grist for bulls?  

If Wetherspoon’s valuation was closer to net assets and without its extent of gearing, I might say to conservative investors holding the stock in a SIPP or ISA, you might hold on because the chain’s food and drink marketing skills will win again, eventually. Just “avoid” with fresh money, say until after Christmas when we could see a share price low around a like-for-like trading update.  

But there is no leeway in the valuation, and there now appears a downwards line of least resistance. As I write soon after today’s open, the stock has eased another 3% to 750p. However, Young’s is slightly firmer at 920p. By 9am however Wetherspoon has regained 775p which could constitute some extent of support if it holds.

Short selling data shows no stock on loan, at least in positions over 0.5% of Wetherspoon’s issued share capital. Indeed, the trend in the last three years has been a reduction from 6% shorted to none at all, as of early 2020. I think hedge funds are behind the curve unless no institutional holders wish to lend out equity. If Covid-19 cases soar this winter and government has to choose between keeping pubs/restaurants or schools open, the hospitality industry will likely suffer. 

Realise that much remains uncertain and the current drop is in reaction to high-profile news. But in the short to medium term I doubt bulls can muster optimism to prop up the chart. Interims are due Friday 9 October, and they’ll be challenged to provide fresh impetus. So, with the shares at around 775p, I maintain my current stance: Sell. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.