A cheap and cheerful pub chain to buy now

JD Wetherspoon’s shares have slumped this year. Yet a recovery is now in sight, says David J Stevenson.

Which stocks do you buy when recession looms? High-technology firms? Utilities? The safest consumer staple (a retailer of essential items)?

The problem is that shares in these sectors may still be holding their own, despite signs of an impending downturn. Investors’ expectations may still be bullish over the long term, with pullbacks seen as a buying opportunity. In other words, there may not be many chances to snap up these stocks on the cheap.

Contrarians, by contrast, go where most other investors are afraid to tread. Consumer cyclicals are a classic case in point. We’re talking about companies that are highly dependent on how much money people can afford to spend on discretionary items such as holidays, furniture, cars and entertainment.

Buy when markets are gloomy

Shares in these stocks are likely to fall sharply as a recession approaches, as is the case now. Yet just as the outlook seems about as dire as can be, they often start to recover in anticipation of an economic rebound. Investors who buy in the depths of gloom and doom can make massive returns in the bounce back.

Publican JD Wetherspoon (LSE: JDW), is firmly in this category. Founded in 1979 by Tim Martin, who still owns a fifth of the firm, it grew strongly in its early days. It listed on the stock exchange in 1992, at which point it had 50 pubs. Within two years, Wetherspoon had doubled its estate.

In 2001 Wetherspoon had opened its 500th outlet and was recognised as Britain’s fastest-growing company and the ninth-fastest-expanding firm in Europe. After reaching the 900-pub milestone in 2013, the company began rationalising its estate and expanding its hotel business. It currently has 859 pubs and 57 hotels.

Having tripled between the beginning of 2005 and early 2007, Wetherspoon’s stock price crashed during the financial crisis. Having troughed at 175p in July 2008, two months before investment bank Lehman Brothers went bankrupt, the shares rallied to £17 at the end of 2019. That’s a stunning 870% return, and shows how even sectors as unfashionable as pubs can make investors rich.

Then, of course, Covid-19 hit. Wetherspoon’s shares more than halved as a result of lockdowns. Despite subsequently doubling as pandemic fears receded, they have since fallen to around £5 as the company began making losses amid warnings about climbing costs. Indeed, the recent increase in inflation – in particular soaring energy costs – has become another deterrent for customers considering pubs.

A solid niche

In spite of this gloomy backdrop, however, there are reasons for optimism. As Rupert Steiner points out in Barron’s, Wetherspoon’s “fundamentals that set it apart from rivals – it has a niche selling inexpensive pints of beer in unfussy venues – remain solid. Value-conscious consumers are sure to find this approach attractive.”

Steiner notes that the company “will also benefit from its strategy of owning larger pubs rather than a collection of smaller ones; that will provide savings in rent and labour”. In turn, Wetherspoon is likely to continue to pick up market share over the longer term. And measures by new UK prime minister Liz Truss to limit soaring energy bills should improve consumers’ discretionary spending, helping firms such as Wetherspoon.

The share price is back at its level of ten years ago. It’s been a painful experience for buy-and-hold investors. Yet for new players, it could be time to consider snapping up the stock at today’s bargain-basement levels. We look at the latest news from the chain, and its valuation, below.

Keeping a tight lids on costs

JD Wetherspoon share price chart

Wetherspoon has said that like-for-like sales in the first 11 weeks of the quarter to 31 July 2022 were 0.4% lower than the same, pre-pandemic, period in 2019. This was an improvement versus the 4% sales drop in the previous quarter.

Sales of spirits (up 4.4%), cocktails (18.6%), food (2.1%) and hotel rooms (8.4%) rose in the quarter, but turnover in draught ales, lagers and ciders – the largest past contributors to pub revenues – were 8% below 2019 levels. Wetherspoon says that it has invested heavily in labour, repairs and marketing to strengthen its position for the new year that started on 1 August 2022.

Losses for the previous financial year will therefore be higher than expected at about £30m. There is no dividend, nor was any restoration mentioned in the update.

Wetherspoon owns 68% of its estate. The net book value of property, plant and equipment in January 2022 was £1.4bn, including £1.1bn of freehold and long-leasehold sites that haven’t been revalued since 1999.

However, this illustrates both strengths and risks inherent within the firm. Net debt after derivatives and lease liabilities was also £1.4bn. So Wetherspoon is not only a consumer-dependent pub chain, it’s also a highly leveraged property play.

Yet there were positives. The firm has secured its energy supplies until August 2023 at fixed rates that predate the current price spike. It has arranged long-term contracts for many bar and food purchases. As a result, Wetherspoon believes that in this financial year its overall costs will increase by less than current inflation.

On a forward price/earnings (p/e) multiple of 12 for this year, falling to 10.6 for the following year, Wetherspoon’s looks cheap. The stock could slip further but there is scope for a large recovery.

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