We’ve heard of disguised profit warnings, but JD Wetherspoon PLC (LON:JDW) appeared to release the opposite this morning, sparking an upgrade from Peel Hunt.
The broker has moved from ‘sell’ to ‘hold’ after the pubs group said it anticipates a slightly improved trading outcome for the current financial year, compared with its expectations at the time of its November trading update.
The broker has upgraded its forecasts by around 10% and ramped up the target price to 925p from 616p.
“With higher relative costs (lower margins), JDW is more exposed to cost inflation than its pub peer group, in our opinion. Also, its pricing differentials against the supermarkets are likely to be forced even higher due to current inflation being orientated to labour (costing the equivalent to 85p/pint at JDW vs 10p/pint in supermarkets) and rates (17p/pint vs 2p/pint),” Peel Hunt’s Douglas Jack said.
By Jack’s calculation, to hold cash margins Wetherspoon would have to raise prices by 5p a pint versus 0.6p a pint for supermarkets to do the same.
Generally, the pubs operator’s like-for-like profits have weakened historically when commodity costs have risen, he noted.
The broker observed that in the first half of the current financial year, two pubs were opened and 21 were sold, signifying a change in the Wetherspoon model.
Time was when the group would achieve growth by acquiring a site – perhaps a rival’s pub or maybe an old bank branch – and turn it into a typical value-led, if somewhat soulless, Wetherspoon establishment.
Now, the model seems to be more about focusing on higher quality pubs.
“The estate average quality is improving and most of the estate is now freehold,” Jack said.
Comparing enterprise value (EV) – essentially market capitalisation adjusted for cash or debts – and underlying earnings (EBITDA), the shares have re-rated to 8.9x EV/EBITDA, versus a 10-year historic average multiple of 7.4.
“Our 925p target assumes the EV/EBITDA rating holds in 2018E, a year that should bring greater cost pressures, and will require further price increases to compensate,” the broker said.
Shares in Wetherspoon were up 30p to 932p towards the end of the morning trading/drinking session.