Further Upside In Post-Lockdown Britain: J. D. Wetherspoon

Summary

• Wetherspoon is a best-in-class pub chain with strong financial history.
• Its pubs have all been closed in lockdown but its shares have still doubled from their lows on anticipation of recovery.
• Once U.K. pubs reopen next month and are very busy I expect a positive rerating.
• Over 30% upside in next 12 months.

Introduction

The pub is well known as core to British social life, but a lot of British people are currently suffering at home without the option to go to the pub, a key social location. In coming weeks, as lockdown restrictions ease, this will change.

Thesis

Many people in the British Isles want to drink, they want to drink cheaply and there will be less competition in the U.K. market after lockdown ends than there was before it began. One big winner from this will be pub chain J. D. Wetherspoon (OTCPK:JDWPY) (OTCPK:JDWPF). Its shares are already trading at a fairly high multiple, but I believe there is significant upside in the one-year time frame anyway as once pubs reopen the shares will receive a momentum boost and rerating.

Image: company website

J. D. Wetherspoon: A Well-Run Popular

Wetherspoon is a chain of 859 pubs at last count (2019 annual report) spread across the U.K. and Irish republic. These pubs in fact serve meals and hot and soft drinks so function as cafés during the day, traditionally a time when pubs were underutilized.

The best way to understand why Wetherspoon's is a great business is to go into any of their branches, at any time. Invariably they are busy. The client mix is unusual for a pub: pensioners rub alongside young, rowdier groups. The prices are cheap but the products on offer are still good quality. This, in my opinion, has been the reason for Wetherspoon's success. It might not be the dream pub, but it offers a consistent, decent product at a highly competitive estate. As the number of pubs in the U.K. has fallen, the large Wetherspoon outlets often also benefit from their locations.

However, being a great business does not always make for a great shareholding. Wetherspoon's successful formula has pushed the share price up. COVID-19 presented a buying opportunity.

The company came in for some criticism during the COVID-19 crisis, first for its desire to keep pubs open and then for its treatment of staff. The company founder and chairman Tim Martin is synonymous with it and the media love running his sometimes politicized soundbites (for a more even-handed analysis, the Weekend FT ran a good profile of the company a few months ago here). Like Ryanair's Michael O'Leary, Martin's statements make the headlines, but I doubt they will much impact the business. The company initially said it wouldn't pay staff until a government wage subsidy scheme kicked in, but in fact staff were paid. 99% have been furloughed, according to a trading update. Those who left to work elsewhere were also told they would be first in the queue for jobs when pubs reopened. So although the company didn't have a good crisis on the PR front, I don't think there will be a material impact on it in terms of staff relations. Incidentally, Martin owns more than 30% of the company and his percentage stake has actually been increasing over the years.

Despite the lockdown, the shares have already more than doubled from their March lows, even before their pub estate has re-opened.

Source: Google Finance

Wetherspoon is Positioned to Win after Re-Opening

The U.K. is gradually easing lockdown restrictions. Pubs will likely re-open in England on 4th July and my expectation is that Scotland, Wales and Northern Ireland will be close behind. There will be some anomalies re-opening, but it seems reasonable to expect that bar another lockdown, pubs will be operating across the U.K. in August. There may well be COVID-19 connected hygiene and distancing requirements which mean that those operations are significantly different to normal operations, however.

My expectation is that pubs will do a roaring trade once re-opened. Many people are desperate to get out socializing and drinking - in my part of Scotland last weekend, loads of gardens were hosting barbecues with heavy drinking mid-afternoon. A lot of canceled summer holidays abroad mean that the leisure drinking often carried out elsewhere will be reshored to the U.K.

Additionally, a lot of pubs in the U.K. which have closed for lockdown may not reopen because their owners have decided that they are economically unviable. Chains like Wetherspoon should soak up some additional custom from this source.

Against these positive elements, there are a number of threats to consider.

1. Some groups will be slower and more cautious to embrace reopened pubs than others. Elderly men are at high risk from COVID-19 and are also an important part of the pub going population. If they take months or years to feel confident getting back to pubs as normal, that will impact Wetherspoon as other pubs.
2. Distancing and hygiene rules could reduce revenue and profitability. A Wetherspoon pub in its busy times often has ever table full. Spacing punters out and slowing down ordering/delivery of drinks could reduce occupancy significantly. This is an industrywide challenge and I feel confident that Wetherspoon will have as good a response to it as anyone, maybe after a few weeks of trial and error to optimize the solution.
3. People will be less likely to spend on the on-trade. For months, declining disposable income and lockdown mean that people have got used to drinking from the off-trade. For example, my own weekend pub visits have been replaced by home drinking with beers bought from the supermarket. A lot of people will race back to the pubs, but a key question is how complete that cohort will be. How many people, having had months to compare the cost of home drinking to pub drinking, will decide that the pub is an unnecessary expense during a tight of economic belt tightening?

Additionally, despite the bad press, Wetherspoon has demonstrated commendable vision and leadership during lockdown, as per its trading update. It has stopped its opening program and key board members including Martin have taken a salary cut of half. It has deferred payments including taxation by agreement and cancelled the interim dividend.

Wetherspoon Shares are Not Cheap but Will Rise

With its competitive prices, Wetherspoon is basically a low margin business.

	2015	2016	2017	2018	2019
Revenue (£M)	1,513.92	1,595.20	1,661.00	1,693.82	1,818.79
Net profit (£M)	44.82	51.21	56.58	66.71	72.78
Net profit margin	3%	3%	3%	4%	4%

Click to enlarge

Source: Table calculated and compiled by author using data from company annual reports

That makes it more susceptible to sustained trading shocks such as lockdown. However, it is an exceptionally well-run business. It has a long record of year-on-year revenue growth.

Source: chart compiled by author using data from company annual reports

It has achieved this revenue growth while achieving strong earnings growth. Free cash flow has also grown strongly over the long-term. The dividend is always well-covered and when prudent the company suspends it, as it did this year, but it weathered the financial crisis as just a blip.

In other words, this is a solidly run business. It has taken steps to minimize cash outgoings. It will emerge from lockdown in a strong position, and with its estate ready to go whatever the new requirements are.

When pubs do open again, Wetherspoon pubs will be full and there will be positive momentum around the shares. Within twelve months, I would expect them to test the 1600p mark again, a 37% uplift from today's price.

Conclusion

J. D. Wetherspoon is a quality act: compelling product and strong financials. That has been reflected in its share price, which is not at a low p/e and indeed has doubled even while its estate is closed. But when it reopens there will be a significant lift as the market factors in the fact that the company's strengths remain, while competitive pressure is slightly reduced at least in the short- to medium-term. I expect the shares to test 1600p within twelve months.

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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Noah Riley]

Good concise article - thanks. Really do like the appeal of Wetherspoons. The simple nature of cheaper beer truly has filled a gap in the market. The attractiveness of Wetherspoons for consumers is huge, particularly for young people like me, its the go to first choice.

[Retirement Pot]

Thanks Noah for the kind comment.
I agree that what Spoons does well is manage to attract groups which are usually mutually exclusive in pubs e.g. young groups, solo pensioners and families. Presumably like you, I'm looking forward to sinking some pints in one again soon.