Margin woes to weigh on Wetherspoon

Sliding profit margins and tough trading in 2013 look set to continue the downward pressure on JD Wetherspoon's share price

February 21, 2013

by Algy Hall

Pubs operator JD Wetherspoon (JDW) has a reputation for pursuing sales at the expense of profit margins. In the long term this can make sense because it's good to get sales in the bag and profits can arrive later. The trouble is that institutional investors - notoriously short-termist - don't necessarily think that way, a factor that may hit Wetherspoon's share price, which is already showing signs of weakness.

IC TIP: Sell at 510p

Tip style

Sell

Risk rating

High

Timescale

Long Term

Bull points

Sales growth
Limited exposure to rising food prices

Bear points

Falling profit margins
Tough consumer outlook for 2013
Cost inflation
High rating compared with rivals

Wetherspoon has seen a marked slip in operating margins in recent years (see chart), and broker Liberum Capital forecasts that profitability will slump to a 20-year low in 2012-13. To date, the market has been fairly forgiving - in the past year Wetherspoon's share price is up 24 per cent compared with 30 per cent from the FTSE 350 Travel & Leisure sector overall; and since its low point in May it has outperformed the sector, rising 35 per cent compared with 33 per cent.

Part of the strong performance reflects investors' enthusiasm for what should be recovery stocks, but it may also reflect Wetherspoon's sales growth. In the first 11 weeks of the second quarter, like-for-like sales rose 8 per cent and total sales were up 11 per cent; and for the 24 weeks to 13 January like-for-likes were up almost 8 per cent. Yet, now there are signs that the market is getting nervous about Wetherspoon's prospects; that's based on a 2.6 per cent fall in its share price over the past three months compared with an 18 per cent rise for the sector.

JD Wetherspoon (JDW)
ORD PRICE:	510p	MARKET VALUE:	£643m
TOUCH:	510-515p	12-MONTH HIGH/LOW:	554p	367p
DIVIDEND YIELD:	2.4%	PE RATIO:	13
NET ASSET VALUE:	135p	NET DEBT:	273%

Year to 29 Jul	Turnover (£bn)	Pre-tax profit (£m)	Earnings per share (p)	Dividend per share (p)
2009	0.96	45.0	18.2	nil
2010	1.00	60.5	29.3	12
2011	1.07	61.4	35.4	12
2012	1.20	58.9	35.6	12
2013*	1.24	71.0	39.2	12
% change	+4	-2	+0	nil
*Liberum Capital underlying forecast Normal market size: 2,000 Matched bargain trading Beta: 0.6

Yet 2013 is shaping up to be another tough year for leisure companies and the pub sector's 'value' players may need to sacrifice more profit, even while they find sales growth harder to come by. Recent data for January from the Coffer Peach tracker makes for worrying reading. The monthly survey, which is compiled from sales data from 25 leading pub and restaurant chains (although not Wetherspoon), suggests times are tough. Part of the 2.4 per cent like-for-like fall in January can be explained by horrid weather, but Peter Martin of Peach Factory, a consultancy, says: "The underlying trend is of a tightening eating- and drinking-out market. These figures represent a downward trend [since August]. It is increasingly becoming a fight for market share."

And it is not just flagging demand and increased competition between pub chains that is a concern. Cost increases, partially driven by higher tax on drinks, are a constant problem for pubs operators. With cheap meals becoming an increasingly important part of the sales mix, food price inflation is another issue. That said, only 31 per cent of sales of Wetherspoon's revenue comes from food sales, making it one of the least exposed pub operators to this growing segment of trade, according to broker Liberum Capital.