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Sat 12th Sep 2015 - JDW: management comment and analysts’ concerns
Below, Propel reports on JD Wetherspoon management comments from yesterday’s results meeting and key analyst concerns

Freehold proportion of estate nears 50%, spending record amount on development costs: The freehold proportion of the 951-strong JD Wetherspoon estate has hit 49%, which is an 8% rise on the 2006 figure. Freehold ownership was helped by the company buying-in 12 freehold sites in the year where it was previously the tenant at a cost of £21.6m. Wetherspoon spent a record amount of £2,070,000 (excluding the cost of freeholds) developing 30 pubs in the year, which is £427,000 more than the previous record set in 2014 when £1,643,000 was spent developing each pub. A total of 30 pubs opened in 2015 and had a average size of 4,321 square foot, which is 20% above estate average. The average freehold cost was £843,000, a jump of £304,000 on the year before and the highest since the company paid £857,000 for each freehold in 2010. Average population within two miles of the 30 openings in 2015 was 58,000, a 21,000 increase on the year before and the biggest population density since 2010 when the figure was 67,000. Chief executive John Hutson said that had been no intention to build bigger pubs in 2015. “It was more something that revealed itself as time went on. And last year we opened in some of the smallest town we’ve ever opened in – we’ve just opened in Tavistock, Devon (population: 11,018).” The company expects to open 15 to 20 new pubs in the current financial year

Ebitda per pub: Average Ebitda per pub was £200,900 in 2015, which was a drop of £3,600 on the year before – in 2007, Wetherspoon produced £219,000 per pub. Hutson said the company has done well to keep its average pub Ebitda consistent over the years. He noted that current weekly average per pub sales of £37,4000 gross are 24% higher than they were five years ago – they stood at £30,100 gross per week per pub in 2010. Food now stands at 37% of pub sales, up from 23.2% in 2003. Hutson forecast like-for-like sales growth of between 0% and 2% in the current year.

Wetherspoon is UK’s favourite big brand: Hutson reported Peach BrandTrack consumer research that shows that the company remains the UK’s favourite big brand. Asked which of 17 well-known brands consumers would choose first to eat at if all were available in the same location, 12% chose JD Wetherspoon followed by Nando’s (7%), Toby Carvery (7%), PizzaExpress (6%), Wagamama (6%) and Harvester (6%). Hutson added that 296 Wetherspoon pubs appear in the 2016 Camra Good Beer Guide. The average food hygiene score across the estate in July this year was 4.93 out of a maximum of five. A total of 94.1% of pubs achieved the maximum score of five. “It’s higher than any other pub or restaurant company of any size,” said Hutson. 

No regional difference in Wetherspoon performance: Hutson said that the company faced increased competition from supermarkets and casual dining operators. Asked whether this was affecting performance in the south east where casual dining brand are opening the most sites, he said: “Not that we’ve noticed – all our regions are performing within 0.5% of each other (in like-for-like sales terms).” 

Average weekly takings in Ireland above UK average: Hutson reported that the average weekly takings of its four Irish pubs, all located in Dublin, is above the UK average of £37,400 per week. He said: “We expected them to be above the UK average – these are our first pubs in the capital of the country. If we were opening for the first time in London, we’d expect (sales at) those to be higher too.”

Manager retention at record level: The company reported that the average manager tenure now stands at ten years and eight months, the highest ever level. Average kitchen manager length of service is also at the highest ever level – six years and ten months. The company now has 36,000 staff, with more than 15,500 jobs created since the start of the credit crunch. Around 10,000 employees are shareholders in the company. Last year saw £30.7m paid in bonuses and free shares to staff, of which 81.5% was paid to staff working in pubs. Wetherspoon estimates that 40% of its profits last year were paid to staff in bonuses. However, the company made 20 head office staff redundant in the year at a cost of £782,000.

Geof Collyer – Wetherspoon a zero sum game again in 2016?: Deutsche Bank analyst Geof Collyer said 2016 could be only the second year since IPO that the Wetherspoon pub estate remains flat because reduced openings of 15 to 20 will be offset by the sale of 20 pubs. He said: “Over the past decade, Wetherspoon has added £666m on sales on the back of circa £770m of development capex, generating just £52m, of incremental Ebitda – an implied return of less than 7%. During the period, the capital return on average capital invested has dropped 210 bps to 9.6% so either the new investments are not delivering or the underlying business is going backwards alarmingly.”

Vaughan Lewis – ten questions for JD Wetherspoon management that investors should focus on: Morgan Stanley leisure analyst Vaughan Lewis has posed ten key questions for JD Wetherspoon management that investors should focus on in the wake of yesterday’s results. He said: “Sales growth continues to slow, and management is guiding to 0-2% like-for-like growth in F16. Ebit margins have been in decline for some years, but the 77bps drop in the 2015 financial year was the sharpest drop in ten years, with the Ebit margin reaching a record low of 7.4%, and with staff cost pressure rising, we see further downside to come. Return on capital has been falling, and with Ebitda per pub under pressure and capital costs rising, we see this trend continuing. Net debt / Ebitda reached a new peak of 3.4x in F15, and the £26m cash return in F15 (dividends and buybacks) results in net debt increasing by £42m. Trading on an estimated F16e P/E multiple of 14x, the valuation is at the high end of its range over the last ten years and the top end of the peers. With all key metrics moving in the wrong direction and ongoing downside risks to forecasts, we reiterate out Underweight rating, Our bull case assumes 3-4% like-for-like sales growth continues, with new product lines contributing to the Ebit margin improving from 7.4% in F15 to 8.0% by F17, with the valuation multiple remaining stable, implying circa 30% upside potential.” His ten key questions were:

1) Like-for-like sales growth has slowed from circa 6% in F13 and F14 to 3.3% in F15 and management is guiding to 0-2% growth in F16. What is causing such a sharp slowdown?

2) Has the expansion into breakfast, coffee and hotel rooms worked? If so, are underlying food, bar and machine sales turning negative now, given the guidance for only flat to marginal like-for-like revenue growth this year, while coffee, breakfast and hotels are ramping up?

3) The Ebit margin was down 77bps in F15 to 7.4%, the sharpest annual margin drop in ten years and a record low. What is the outlook for Ebit margins from here? While management doesn’t tend to focus on Ebit margins, like-for-like Ebit is in decline given that the margin decline is exceeding the sales growth. Why is this the case?

4) The company increased base wage rates by 8% in July. Given high staff cost inflation, broadly flat pub numbers in F16 and management expectation of broadly flat like-for-like sales, how does management plan to meet guidance of flat to slightly increased Ebit? Which costs are significantly lower?

5) As the National Living Wage increases in the coming years, does management expect to maintain the pay differential relative to the industry, or could the gap close slightly, meaning slightly lower cost inflation here in coming years? Could the £31m staff bonus from F15 be used in future as a contribution towards the National Living Wage?

6) Do leasehold pubs make a significant Ebit or cash contribution? If we take year end freehold assets of £876m and apply a 6% rental yield (in line with management comments on recent lease reversions), this implies underlying group operating Ebit (ie assuming that all sites were leased) in F15 of £60m at a 3.8% Ebit margin. Is that the real operating margin of the company, in other words is about half of Ebit due to freehold pubs subsidising leasehold pubs?

7) Debt has reached new peaks in F15 at 3.4x debt / Ebitda (excluding off balance sheet leases), with an increase in debt to pay dividends and buy back shares. Has there been a change in policy for leverage levels? What is the maximum leverage level management would be comfortable with?

8) The CROCCE has dropped from 12.1% to a new low of 9.6% over the last ten years. The capital costs of pubs are rising, and Ebitda per pub is falling. Does it still make sense to open new pubs? Is management still targeting 1,500 pubs in the long term? The estate is likely to be broadly flat at 950 pubs this year, with 15-20 planned openings and 20 smaller leasehold sites up for sale.

9) What further innovation could we see, and could the new revenue streams lead to materially higher revenues, and in time, profits? Management has previously stated a target to triple sales of coffee and breakfast, and last year began to roll out more aggressive pricing to drive volumes. The company continues to roll out more hotel rooms, converting unproductive space to revenue-generating space.

10) Cash flow has seen a material working capital benefit in the last two years, with working capital contributing circa £30m per year, or circa 30% of free cash flow in the last two years. With the openings plan slowing, and 20 pubs up for sale, should we expect a return to the more normal c.£10m working capital benefit, which was the average of the prior ten years? In other words, is there a £20m + headwind to free cash flow for F16?

Nick Batram – Wetherspoon margin recovery seems some way off: Peel Hunt leisure analyst Nick Batram said: “JDW’s message remains consistent; unfortunately this means the hope of any material margin recovery looks some way off. It is possible that the pressure from the living wage and competition leads to another shake-out in the market, and ultimately this could be positive for Wetherspoon. Nevertheless, there seems little need to rush into the shares at the current time. Wetherspoon has one of the highest proportions of staff costs to sales in the leisure sector, with wage costs c30% of sales. The group had moved ahead of the curve in terms of wage increases, but the living wage will be yet another component negatively impacting margin. Unlike many of the sector peers, there is no mention of mitigation to living wages or how Wetherspoon will turn around the margin decline it has faced so far.”

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