Questor share tip: Hold Wetherspoon despite slowing sales

UK pub group says profit margin could slip further as it continues with ambitious expansion plan. Questor says hold.

JD WETHERSPOON
Wetherspoon reported a 4.3pc increase in sales to £996.3m in the year to July 25 Credit: Photo: GETTY

JD Wetherspoon
745p-15
Questor says HOLD

SHARES in pub group JD Wetherspoon [LON:JDW] fell by 2pc yesterday after faltering sales and poor trading during the World Cup hit investor confidence in the company.

However, after delivering gains of almost 40pc during the past 18 months, Questor argues it is too early to be cashing in on the stock’s performance.

An aggressive programme of opening new pubs and restaurants to take advantage of the strong recovery in the UK economy has supported its shares and overall performance in a challenging sector. The company said yesterday that it expects to have opened 45 new pubs during the year ended July and plans to open a further 40 next year.

According to house broker Investec, the pub-opening programme is expected to add about £120m to overall revenue this year, with a further £100m next, bringing total turnover to around £1.5bn.

The expectation is that increasing sales will eventually be turned into profits. However, opening new pubs is expensive and the company has warned it is squeezing profit margins. It said it expects a fall in profit margins for the full year to 8.1pc, down from 8.7pc at the same stage last year. What’s more, the company said margins could fall to 7.7pc next year depending on pub openings and trading conditions.

The expansion programme means that a 9pc increase in revenues last year has not been reflected in pre-tax profits, which are expected to increase by about 3pc to around £80m for the year ending July.

Investors have bought into the shares during the past 18 months in the belief that the transition from increased sales to increased profits will be reasonably smooth. Yesterday’s update demonstrated that the transition might be a little delayed but the overall investment case holds.

Broker Shore Capital said: “We continue to scratch our heads over the margin decline against such strong like-for-like sales growth, noting the continuing investment in the business. However, until we see stability in the margin we retain our 'hold’ stance.”

The company insists it is investing “for growth”. Questor believes that the long-term bet on UK economic growth that is underpinning its strategy will succeed once the first year opening costs for new pubs have been absorbed.

Pre-tax profits should accelerate in each of the next two years, increasing by around 15pc in each reporting period, according to Investec estimates.

However, Questor has concerns that profits could be crimped by new legislation. “The impact of the coalition Government’s 'late night levy’ is starting to take effect, with annual charges of up to about £4,000 per annum for pubs opening beyond midnight in Newcastle and Islington, for example,” the company said.

That said, the pub group generates plenty of cash. The free cash flow of about £70m easily covers the £14.4m in dividend payments. Net debt is forecast to increase to £560m by the end of July, according to Investec.

JD Wetherspoon stepped up its share buy-back programme in the last quarter, with £18.5m being spent in the year for 2.3m shares.

The last time we looked at the shares (Hold, 740p, November 9, 2013) we said investors should focus on the profit margins as we expected them to fall further during the growth phase.

JD Wetherspoon is a great success story and the company has increased sales to £1.4bn, from just £1m 30 years ago. However, the shares remain a hold until we start to see a recovery in the profit margin.