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Wed 21st Jan 2015 - Douglas Jack – JDW trapped by discounting
Douglas Jack – JDW trapped by discounting: Numis Securities leisure analyst Douglas Jack has argued that JD Wetherspoon is suffering downgrade momentum, trapped by discounting as consumers trade up on the fewer occasions they venture out. He said: “Like-for-like sales have slowed from Q1’s level of 6.3%, to 2.8% in Q2, reflecting comps becoming tougher (Q1 3.7%; Q2 6.7%; Q3 6.2%; and Q4 5.2%), largely due to the extension of food trading hours in autumn 2013. In the first 25 weeks, like-for-like sales are up 4.6% and total sales are up 9.1%. More importantly, H1 margins have slipped to 7.3%, down 90bps from H1 2014’s 8.2%. We are cutting our forecasts (2015E by 4%; 2016E by 6%; 2017E by 8%) to reflect a lack of margin support. Margins fell 120bps in Q2 to 6.9%, by our estimates, following a 60bps decline in Q1. This largely reflects average beer prices rising by only 1.1% in the year to December 2014 (source CGA) versus higher increases in labour, utility and supplier costs. Based on CGA data, we estimate that JDW’s beer price discount to the sector has grown over the last three years, from 14.5% to 17.6%, which is unnecessarily large, in our view. We are cutting our forecasts by 4-8%. For 2015E (PBT from £84.7m to £81.2m; consensus £82.9m), they assume like-for-like sales rise by 4.0%, Ebit margins fall 80bps and that 35 new pubs open. For 2016E and 2017E, we now assume no recovery in margins, even though purchasing cost pressure should be benign. That would require management to put prices up sufficiently to cover cost increases, which they are not committed to doing. They appear focused on supermarket competition. Reflecting our downgrade, we are cutting our price target to 875p (from 950p). This, arguably generously, assumes the current 16x P/E (8.4x EV/Ebitda) rating holds. We are forecasting 30% of earnings growth over the next three years, of which most (16%) is due to falling swap costs. With improving consumer cash flow, it is clear that consumers are trading up on the fewer occasions that they venture out. Thus, upgrade momentum is with the restaurants and premium pubs/bars, whereas downgrade momentum is with those trapped in discounting. A premium market position is worth a premium valuation; and a discount market position is worth a discount valuation.”

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