Leading analyst Doug Jack at Numis expects LFL sales at JD Wetherspoon to have slowed from H1’s level of 4.6%, to c.2% in Q3, with margins continuing to fall, compounded by additional breakfast/coffee discounting and weaker LFL sales.
Despite this, Jack, who reduced his target price for the group’s shares to 680p, expects to hold 2015E forecasts, but believes there is downgrade risk to 2016E.
He said: “LFL sales should have slowed to c.2% in Q3, from H1’s level of 4.6%. LFL sales slowed to 1.6% during the first six weeks of H2, having slowed to 2.7% in Q2, partly due to comps becoming tougher (Q1 3.7%; Q2 6.7%; Q3 6.2%; and Q4 5.2%), reflecting the evening extension of food trading hours in autumn 2013.
“The company started its attempt to boost early morning food trading on 18 March through discount-driven coffee and breakfast campaigns. Even if this initiative succeeds, it should need time to increase breakfast trade, and we question whether the resultant volume growth will be sufficient to offset the inevitable hit on margins.
“In H1, EBIT margins fell 75bps, causing EBIT/pub to fall by 5%, with low price increases (1% on drink) having hurt margins more than they benefited volumes. Due to LFL sales slowing, annual drinks price inflation remaining at 1% during February and March, as well as further dilution from discounting breakfasts, we forecast EBIT margins to fall 85bps over the full year.
“Since 1 January 2015 we have cut our 2015E forecast by 8% (PBT from £84.7m to £77.5m; consensus £78.0m). For 2016E, we believe there is downside risk to our forecast of EBIT margins falling 5bps (consensus: flat). Although proportional rent costs should fall (due to freehold expansion) and food costs should be subdued, labour cost inflation has picked up.
“JDW expects to open 30 pubs this year, down from 46 in 2014. With freeholds accounting for a rising share of new sites, we estimate net debt/EBITDA reaching 3.6x in 2015E, and continuing to rise in 2016E and 2017E. This can only be exacerbated by the ongoing share buy-back programme.
“Our 680p target price equates to 8.1x EV/EBITDA, above the company’s 7.5x historical average rating even though prospects are below-average. For example, average EBIT/pub has increased by a total of 2% over the 12 years to FY14; whereas average EBIT/pub fell by 5% in 1H15 alone.”
