Interactive Investor

Stockwatch: winter Covid fears cast shadow over this pair

12th November 2021 11:51

Edmond Jackson from interactive investor

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After comparing these two popular stocks, our companies analyst reveals his favourite. But should you buy either of them?

Despite net asset values being out of fashion in a long-term bull market, they can be useful on both the equity long side and the short side as a benchmark for likely mean reversion in price. 

A relevant comparison is two pub groups: £1.2 billion J D Wetherspoon (LSE:JDW) and £842 million Young & Co (LSE:YNGA). Both have suffered around a 10% decline in revenues versus their comparative periods in 2019, i.e. adjusting for the 2020 trough caused by lockdowns.  

At 955p, Wetherspoon trades on what is objectively a high multiple of net asset or ‘book’ value, 4.5x (despite the fact that very little is involved in the way of intangibles or goodwill). Meanwhile, at £14.70, Young’s is just shy of 1.4x book value. 

The Wetherspoon multiple was previously even higher, given the chart shows a rise to near £14 last springtime, but at least the stock has mean-reverted back to November 2020 levels when Covid vaccines first appeared. 

In principle, asset values are relevant for what they can earn, and also, in ‘discounted cash flow’ terms, for the 'terminal value’ they would fetch if sold. I would still pay attention when stocks under- or overvalue net assets, because a material change in underlying revenue/profit raises the odds of change also in market price. 

In practice, this means that, while Young’s shareholders can feel a sense of comfort because downside risk is limited by a strong element of property asset value within the market price, Wetherspoon holders are more exposed. 

I am not surprised: short-selling data show that on 3 November, JPMorgan Asset Management edged up its short position to 0.53% of Wetherspoon’s issued equity, whereas Young’s has zero reported short interest. No one is likely to gamble on a sustained de-rating of Young’s because the asset component to its stock price is so strong.  

In fairness to Wetherspoon, JPM’s short is the only such position disclosed over 0.5% and there have been no disclosed shorts since early 2020. But if the underlying business trend remains challenged, shorts are likely to increase. 

Older customers cautious of Wetherspoon; Young’s refurbishes 

Both companies have updated: Wetherspoon, by way of an update for recent weeks which amount to its first financial quarter; and Young’s by way of interim results to 27 September.  

Wetherspoon faces a dilemma in that its older clientele is staying away (which seems likely to worsen during the winter viral season), so draught ale sales are down, whereas those of cocktails, vodka and rum have risen as younger people feel more relaxed about going out. Food sales have been affected by working from home, with breakfast sales down 22% and coffee by 30%. Total like-for-like sales are down 9%.  

Young’s has professed a radical improvement for its first half-year to 27 September, albeit on 2020. Revenue nearly trebled at close to £150 million, with a £17 million operating loss becoming a £27.5 million profit. 

But looking back to 2019, revenue was £168 million and operating profit £31 million – so recent performance involves circa 11% declines. 

Management says its successful re-opening since 21 June was assisted by a major capital expenditure programme in the last financial year – including garden stretch tents, heaters and new furniture “to ensure we were ready to hit the ground running”. Yet summer has been a relatively easy period to entice people into outdoor-type settings. Winter will be a different proposition and people’s willingness to go to the pub will to an extent be governed by Covid statistics. 

The generally more affluent profile of Young’s clientele means I am inclined to rate its stock a ‘hold’, because past recessions have shown British people are unlikely to give up on eating/drinking out if they can afford it. 

‘Spoons’ has also previously benefited in harder times, at least relative to restaurants, because of its cheaper food and drink. It is not clear, though, whether price alone will be enough to tempt people aged over 50 back into the pubs. Meanwhile, tax rises conflating with higher living costs may take some edge off youngsters’ discretionary spending.   

Management says it has overcome supply chain issues, although the busy Christmas period is yet to come. There has been a reasonable level of job applications and the number of employees has increased since April. 

It is a hard call on human behaviour, but on valuation I feel more confident saying Young’s is fairly valued while Wetherspoon’s stock has the greater downside risk. Net asset value is a factor. 

Cash flow valuation is more attractive than earnings 

In fairness also to Wetherspoon, the table shows how, pre-Covid at least, free cash flow per share was trending at around a 30% premium to earnings per share (EPS); if the company can recover that – say to about 100p per share – then at 960p the cash flow multiple is arguably in single figures. 

Holders can therefore take some comfort that if Wetherspoon can manage its way through the Covid era – yet its stock was to drop – then buy-out financiers could be attracted. Tim Martin, the 66-year-old founder, owns 22% and must be amenable to a takeover as time marches on. 

You could therefore say this cash flow aspect to the business is as much a protection against downside risk as assets, considering the latter can only be valued for what they can earn. Against that, sites can be re-adapted for other purposes, including accommodation. Both pub groups have an aspect of leasehold properties, though they account for just 8% of Young’s total property assets versus nearly 20% for Wetherspoon. 

I suspect it means Wetherspoon is hardly a ‘conviction sell’, which is why hedge funds are not busily shorting – but holders should be alert.  

Reflecting general over-valuation in an equities bull market?  

The progression of market value seems illustrative: 

In November 2010, I was a fan of Wetherspoon at 415p, representing 11x forward earnings when management was expanding good-value food and drink and had introduced breakfasts.  

In September 2019 I changed to ‘sell’ at £15.50, which represented 5x net asset value, a forward price/earnings (PE) over 20x and prospective yield just 0.8%. An underlying trigger was a slight fall in profits due to not passing on higher drinks costs. I kept a ‘sell' stance at £11.80 in June 2020, but also at 775p that September.  

Net profit expectations are for £63 million in the current financial year to 25 July, rising to £78 million in 2023, which broadly recovers pre-Covid earning power (see table).  

J D Wetherspoon - financial summary
year end 25 Jul 2016 2017 2018 2019 2020 2021
Turnover (£ million) 1,595 1,661 1,694 1,819 1,262 773
Net profit (£ million) 51.2 56.6 66.7 72.8 -97.6 -181
Operating margin (%) 6.7 7.2 7.2 6.9 -3.2 -16.3
Reported earnings/share (p) 43.4 50.8 63.2 69.0 -91.6 -147
Normalised earnings/share (p) 48.3 80.1 81.7 75.9 -153 -289
Operational cashflow/share (p) 111 159 167 165 15.7 -28.7
Capital expenditure/share (p) 28.4 52.6 65.3 51.5 41.6 18.2
Free cashflow/share (p) 82.6 107 102 113 -25.8 -46.9
Dividend per share (p) 12.0 12.0 12.0 12.0 0.0 0.0
Covered by earnings (x) 3.6 4.2 5.3 5.8 0.0 0.0
Return on total capital (%) 10.2 11.0 10.6 10.5 -2.1 -7.5
Cash (£m) 46.1 50.6 63.1 43.0 174 45.4
Net debt (£m) 651 696 726 737 1,390 1,369
Net assets (£m) 207 258 287 317 317 278
Net assets per share (p) 183 237 272 301 264 216
Source: historic Company REFS and company accounts

That represents a forward PE of 21.5x, reducing to 15.4x, and potentially the cash flow multiple could be nearer 10x as explained. But I think winter is likely to prove challenging.  

It is tricky to judge how the two pub chain clienteles might behave. This is where I find asset value helps define a stance on the stock. Shorn of £33 million goodwill, Young’s net asset value is £620 million or £10.61 a share. Its rally from around the 800p level in October 2020 could also be described as a mean reversion, after Covid vaccines provided a trigger. 

It will be interesting to see how valid this perspective proves, for stock outcomes in six months’ time (at least). While Young’s amounts to a cautious ‘hold’, I find Wetherspoon riskier, hence I maintain: Sell. 

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

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