JD Wetherspoon (JDW), the managed pub operator led by Tim Martin, could struggle to pass on increased costs and maintain volumes, according to a leading analyst. Douglas Jack at Numis said: “JDW should face more intense cost pressure in 2012E. There is a risk that the company will struggle to both pass these costs on and maintain volumes against a backdrop of falling high street consumer footfall and an eroding pricing position. “Against our estimate that the company needs 3-4% LFL sales growth to maintain margins, Thursday 3 Nov’s Q1 IMS should provide the first marker on JDW’s downgrade risk. After recent strength, we would reduce holdings.” Jack described the company’s a “selling opportunity” with a target price of 375p for its shares. Looking toward next week third quarter update, he said forecast that like-for-like sales should have picked up since August’s riot-affected 0.4%. He said: “Our forecasts assume 2.0% like-for-like sales over the full year, but this is not enough to offset £29m of incremental external costs in 2012E (food and drink £15m; staff £7m; utilities £4m; carbon levy £2.5m). Thus, we forecast Ebit margins fall by 30bps, estimating that 4.2% like-for-like sales is needed to offset cost inflation prior to expansion efficiencies. “Consensus forecasts assume 5bps Ebitda margin growth despite anticipating total sales being only in line with estate expansion. Without like-for-like sales growth, this margin outcome should be difficult to achieve. For example, Ebitda margins fell 72 bps in 2011 due to £23m of external cost inflation even though lke-for-like sales increased 2.1%. JDW’s management’s view is that it will not chase margins, which may fall.” The analyst said that JDW’s eating-out proposition should be defensive, “but half of its custom is drink-led”. He said: “Here, the company is having to impose above-average price increases to a price-sensitive customer base in a falling high street footfall environment, resulting in a narrowing drinks price discount to the on-trade competition (now down to 9.6%) and an increasing price premium to the off trade. “Consensus forecasts have fallen by c.5% in recent months to our level, but we believe the risk to both our and consensus forecasts is on the downside. Like-for-like profits have fallen in each of the last four years despite the depreciation charge rate being cut to 4.2% (of sales) from 6.0% in 2005 and 5.0% in 2007. Given these trends and the downside risk to forecasts, the shares are fully valued in our view.”