Leading analyst Jamie Rollo at Morgan Stanley outlines key questions that he thinks investors could focus on in regards to JD Wetherspoon, including whether the group’s expansion into breakfast, coffee and hotels has worked; whether it believes its investments in wage and other costs are being successful in driving sales and profits; and is management still targeting 1,500 pubs in the long term?
Rollo said: “LfL sales growth has slowed from c.6% in FY13 and FY14 to 3.3% in FY15 and 2.4% in Q1 FY16 (including a benefit from the Rugby World Cup). What is causing such a sharp slowdown and what is a realistic runrate for the rest of FY16?
“Has the expansion into breakfast, coffee and hotels worked? If so, are underlying food, bar and machine sales turning negative? Can these revenue lines be broken out?
“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.
“The EBIT margin was down 150bps in Q1 FY16 to 6.2%, the sharpest annual margin drop in 10 years and a new record low. What is the outlook for EBIT margins from here? While management doesn’t tend to focus on EBIT margins, LfL EBIT is in decline (c. 18% in Q1) given that the margin decline exceeded LfL sales.
“Could management touch on guidance for FY16 EBIT to be only “slightly lower”? Q1 total sales grew by 6.1%, and margins fell from 7.7% to 6.2%, implying Q1 EBIT fell 15%. Even though wage cost pressures ease in Q2-Q4, could guidance for “slightly lower” FY16 EBIT prove optimistic?
“Does the company believe its investments in wage and other costs are being successful in driving sales and profits? The company cites external factors for much of its cost pressures - how does the strategy to drive sales growth affect this?
“As the National Living Wage increases from April 2016, 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 FY15 be used in future as a contribution towards the National Living Wage?
“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 (i.e. assuming all sites were leased) in FY15 of £60m, just 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?
“Debt looks set to reach new peaks in FY16e at 3.5x debt / EBITDA (4.7x including off balance sheet leases); what is the maximum leverage level management would be comfortable with. Is high leverage one of the reasons for the slower roll-out and apparent cessation to the rolling share buyback?
“The CROCCE has dropped from 12.1% to a new low of 9.0% in FY16e over the last 10 years. The capital costs of pubs are rising, and EBITDA per pub is falling. How much of this is a higher freehold mix and impact of opening in Ireland? 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 fall slightly this year, for the first time ever, with 15 planned openings and 20 smaller sites up for sale.
“Cash flow has seen a material working capital benefit in the last two years, with working capital contributing c.£30m per year, or c.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 10 years? In other words, is there a £20m + headwind to free cash flow for FY16?”
