A leading analyst has cut its target price for JD Wetherspoon (JDW) shares over concerns that the managed pub operator’s efforts to pass on higher costs to protect margins could disproportionately reduce like-for-like volumes and profits, “further eroding its value positioning”.
In a note titled the Squeezed Bottom, Douglas Jack at Numis said: “Consensus forecasts are over-optimistic, in our opinion, expecting margins to be flat in 2012E despite an estimated £29m of incremental external costs; in comparison, an estimated £19m of incremental external costs contributed to margins falling 50bps in 2011E. It is unlikely to be easy for JDW to pass on increasing costs to its squeezed, price-sensitive customers. Combined with numerous other concerns, we believe the risk to consensus 2012E forecasts is firmly on the downside and recommend reducing holdings.”
Jack said that medium-term risks for the company include increased competition following Stonegate’s merger with Town & City, which he said is likely to expand value brands, like Yates’s (currently selling Scampi and Chips for £1.99); machine gaming duty potentially undermining machine income (which generates an estimated 31% of EBIT); and higher licensing costs.
He said: “JDW is less well-positioned than its peers. It is more exposed to food/drink cost inflation due to its cost of sales being the equivalent of 36% of sales versus for 28% its quoted peers, by our estimates. It is more reliant on price-sensitive, drink-only custom and related machine income. It is less hedged against increasing cost inflation and is more exposed to changes in licensing costs/laws.
“Our greatest concern is that JDW's efforts to pass on higher costs to protect margins could disproportionately reduce LFL volumes and profits, further eroding its value positioning: since December 2008, JDW’s average drinks price discount to the market has fallen from 15% to 10%. We are cutting our target price to 375p from 425p, targeting 10x PE 2012E, the same rating as the current peer group average. We believe this is appropriate given JDW's greater relative challenge in trying offsetting higher cost pressures in 2012E.”
The analyst forecast that the group’s 2011E PBT would fall by 8% “by assuming total sales rise 8.4% (versus 7.5% after 50 weeks), margins fall 50bps and a 9% cost of debt, per company guidance”.
He said: “Our 2012E forecast is 3% below consensus; the risk to both is on the downside, in our opinion. For 2012E, we forecast EBIT margins to fall 30bps to 9.2% even if JDW achieves 2.0% LFL sales. This assumes the company achieves £3m of incremental cost savings and that there are no incremental other costs (other than highlighted external costs) versus the £8m that has occurred in 2011E, by our estimates.”
