Opinions vary on the appeal of JD Wetherspoon’s affordable pubs, but the firm’s stock has been a profitable investment. The shares are worth 77% more than they were ten years ago. The dividend has risen by 155% over the same period.
Wetherspoon generates lots of cash flow, and this has been funnelled into rapid growth. The group now has 956 locations around the UK. Sales are 56% higher than they were in 2010.
Yet there are some clouds on the horizon.
Wetherspoon’s operating margin has fallen from a high of 9% in 2011 to just 6.2% in 2015. Interest payments on the group’s net debt of £ 626.1m now account for almost 30% of operating profit. The net debt itself is equivalent to 13 times trailing net profits. As founder and chairman Tim Martin never fails to mention, tax rates are quite high, too.
I’ve been concerned for some times that rising debt and falling margins will combine to bring Wetherspoon’s golden era to an end. The firm’s recent interim results did nothing to persuade me I was wrong. Despite a 6.2% rise in revenue compared to the same period last year, operating profit fell by 10.8%. Underlying earnings per share fell by 16.6% to 19.1p.
On that basis, a significant improvement in second-half trading will be required to meet full-year consensus forecasts for earnings of 45p per share.
A storm in a pint pot?
Am I exaggerating? After all, Wetherspoon’s cash generation remains strong. Free cash flow per share, by the firm’s measure and that of Stockopedia, consistently exceeds earnings per share.
The group’s £626m net debt is only around half its net fixed assets of £1.2bn, many of which are freehold and long leasehold properties. That seems reasonable. If margins remain under pressure or debt costs become problematic, couldn’t Wetherspoon just cut back on new pub openings and use the cash to reduce debt?
Perhaps. But I suspect such a plan would trigger a big drop in Wetherspoon’s share price. After all, it would be a clear signal that the business was going ex-growth. Wetherspoon’s sub-2% dividend yield would no longer be sufficient inducement to hold the stock. Greene King, for example, offers a forecast yield of nearly 4%.
Value? Not really
What do Stockopedia’s algorithms make of Wetherspoon’s current valuation? The shares currently have an uninspiring StockRank of 44…
