• Higher wages erode margins
• Company too indebted
• Footprint decreases as outlets are sold
- An established brand with a distinctive offering
- Return of sales to growth territory
- Swaps limit exposure to higher interest rates
- Rising wages erode margins
- Company too indebted
- Footprint shrinks as outlets are sold
Few UK-based investors need to be introduced to JD Wetherspoon (JDW), or an explanation of its offer. From a single pub in North London in 1979, it has become a fixture on Britain’s high street.
Founder and President Tim Martin’s simple idea of providing patrons with inexpensive pints and hot meals in large venues capable of handling high volumes has been executed very well. JD Wetherspoon has become the third-largest pub operator in the country – behind private equity-owned Stonegate Pub Company, and Mitchells & Butlers (MAB).
Not only that, but until Covid-19 hit, the business was admirably profitable. OK, its low-cost offering meant its margin wasn’t as healthy as some of its peers – between 2017 and 2019 it achieved an operating margin of 7.7%, compared to 11.5% at Mitchells & Butlers, 12.5% to Marston (MARS)and 14 percent at Young’s (YNGA). But his sales volumes were so high it didn’t really matter – in each of those years he generated an operating profit of over £100m.
It did this by increasing its market share at a time when pub traffic was generally in decline. According to the British Beer and Pub Association, more than 14,000 UK pubs, or around 24% of the total, disappeared between 2020 and 2021. Around 46,350 remained at the end of last year. The decline appears to be accelerating further this year, with 50 pubs per month closing between June and September, according to Altus Group. He said the number of remaining pubs in the UK had fallen below 40,000.
The pandemic has clearly done the industry a disservice. Even with significant government support through measures such as the furlough scheme and corporate rate relief, pubcos have seen debt pile up. Rent payments have been deferred rather than forgiven, and people’s return to pubs has been slower and less frequent than operators might have expected, especially in cities where hybrid working has reduced drinks after work.
The result is that many businesses that have yet to fully rebuild sales are facing a range of pressures – rising input costs, weaker consumer spending and rising debt service costs, at best. , in line with interest rate hikes.
JD Wetherspoon has certainly felt the aftermath of this difficult period – after 35 years of uninterrupted profitability it has suffered three successive years of losses, although one-off items including a £27.8m payment from HMRC to settle a landmark dispute over the VAT treatment of slot machines and a £53m gain on the notional value of interest rate swaps resulted in it reporting a pre-tax statutory profit of £26.3m in its latest annual results, published last week.
Excluding one-off items, its cumulative loss over the three-year period exceeded £240m and it burned £125m of cash.
Even after appealing to shareholders for more than £230m through two separate rights issues, its non-lease net debt rose to £892m at the end of July, a increase of £46 million over the previous year and £166 million at the end of 2019.
Including derivatives and lease bonds, net debt was £1.29bn at the end of July, about 7.7 times cash profit of £167m. Wetherspoon has agreed to waive covenants with its lenders until October next year, provided it maintains around £100million in cash.
The company is no doubt hoping that a normalized trading period between now and then will help it generate enough cash to repay some of its borrowings. When announcing its year-end results last Friday, the company said trading in the nine weeks to Oct. 2 had been more promising, with like-for-like sales up 10% from the same period a year earlier.
A big advantage is that the interest rate on much of this debt is quite low. The company has used swaps to effectively lock interest rates at 1.24%, excluding bank margins, until 2031. However, the total cost of its debt last year (including margins) was at 4.46%.
Costs elsewhere in the business continue to climb. As furlough support unfolded, employee payments nearly doubled to £692m last year. According to Numis, Wetherspoon’s labor cost to sales ratio fell from 31% in 2019 to 40%. This has been “the most significant source of margin erosion,” the broker said.
With wage inflation in the hospitality sector of 7% in the year to September – comfortably ahead of the national average wage increase of 5.5%, according to the Office for National Statistics – l he company is likely to face renewed pressure to raise wages. recruit and retain staff.
Although energy costs are covered until the end of next year, he has decided not to cover any longer in the future given current prices. If these remain high, however, the company faces a £100m rise in its energy bill from 2024, according to Numis.
On top of that, Wetherspoon needs to spend more on upgrading its pubs given it had slowed investment during lockdowns to preserve cash. Total capital investment more than doubled to £127m last year.
The pub chain is expected to generate more revenue this year – analyst consensus is that sales will exceed pre-pandemic levels to £1.87billion, according to FactSet, which should see it repay its debt . Around £100million advanced to the company through the government’s coronavirus-related large business shutdown scheme is due to be repaid by next August.
The company can also use proceeds from the disposals of the 32 pubs it recently commissioned estate agents CBRE and Savills to sell. However, getting rid of it would bring the number of outlets it operates down to 855, or below the level it was at in 2012, and well below the 955 pubs it peaked at in 2015.
This raises an important question about growth, especially given its high-volume, low-margin business model.
There’s an argument that JD Wetherspoon could be a net beneficiary of the cost-of-living crisis as people switch from more expensive pubs to its value-driven offering.
It could also make gains by continuing to grow its share of a declining market – there are sure to be smaller pub operators facing similar market pressures, but who don’t possess the same kind of influence to set a so much of their own interest charges. .
The most worrying scenario, however, is that customers with already stretched family budgets are cutting pub visits altogether.
This seems to be the prospect Martin fears the most. Commenting on the company’s latest results, he said the closures had led to many diehard pubers filling their fridges with supermarket beer, adding that it had been “a tall order” to persuade them to come back.
It is not yet clear that they all did. In a mid-July trade update ahead of full-year figures, the company said sales of draft beers, lagers and ciders, which have historically been the biggest contributor to pub sales, had fallen by 8%, perhaps indicating that core demand drinkers have some way to go to recover. Fortunately, this was at least partially offset by higher sales of spirits (up 4.4%), cocktails (up 18.6%), food (up 2.1%) and hotel rooms (up 8.4%). Sales at its 48 Lloyds outlets, which play music and are popular with a younger clientele, were up 6%.
JD Wetherspoon’s market capitalization has fallen from around £1.6bn since the end of 2019 to a current level of just over £650m. Although shares soared as much as a fifth in the days following the results, the stock price continues to suggest that investors expect earnings growth to remain subdued.
The company has continued to make investments – it has spent £158m since January 2020 buying new pubs and converting leasehold outlets into freehold properties – but part of its estate looks tired and it is difficult to to disagree with broker Liberum’s view that Wetherspoons needs repositioning.
Where he generates the money to do so is another matter. Selling ads now offers a quick fix, but it pushes the prospects for profit and growth even further. A short-term top followed by a gloomier reassessment of the outlook for the future is a sentiment that may be familiar to many of its regulars.
|Company Details||Last name||Market Cap||Price||52 weeks high/low|
|JD Wetherspoon (JDW)||£650 million||505p||1055p / 388p|
|Size/debt||NAV per share*||Net Cash / Debt(-)||Net debt / Ebitda||Operating cash/EBITDA|
|Evaluation||PE before (+12 months)||DD (+12 months)||FCF yield (+12 months)||CAP|
|Quality/ Growth||EBIT margin||ROCE||CAGR of sales over 5 years||CAGR EPS 5 years|
|Forecast / Momentum||Fwd EPS grth NTM||Fwd EPS grth STM||Mom of 3 months||% change in EPS before over 3 months|
|End of year 31 Jul.||Sales (in billions of pounds sterling)||Profit before tax (millions of pounds sterling)||EPS (p)||DPS(p)|
|To change (%)||+4||+24||+15||+59|
|Source: FactSet, adjusted PTP and EPS figures|
|NTM = next 12 months|
|STM = Second 12 months (i.e. in one year)|