Trading: Toast the rebound with Wetherspoon

The FTSE 100 index slumped by more than third between the start of the year and the trough at the end of March. Even after a modest rally, the market is still 20% off its peak, so many solid stocks that were previously too expensive are now priced much more affordably. One is the pub chain J D Wetherspoon (LSE: JDW).

Wetherspoon is not exactly a fashionable brand: it is widely deemed to be the Ryanair of its particular trade. However, just as Ryanair has dominated short-haul travel, Wetherspoon has been one of the few success stories in the pub retail trade. It has focused relentlessly on what its customers want: decent food and drink at an affordable price.

Unlike its competitors, it has avoided the perils of over-diversification, staying focused on its branded pubs and a handful of hotels instead of trying to branch out into other areas. Between 2014 and 2019 total sales grew by an average of 5% a year, while earnings per share more than doubled.

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Despite its continued success, the problem with Wetherspoon in recent years has been a very high valuation. It traded at a price/earnings (p/e) ratio of more than 20 while its competitors were far cheaper. As a result, I’ve avoided it in the past as too expensive, and even recommended that you short it in March 2017. However, given that it is now down by a third from its price on 1 January, it is much more affordable. It currently trades on a 2021 p/e of 15.

Of course, the big reason for this fall is that Wetherspoon, like all pubs and restaurants, is currently shut down as part of the lockdown and not due to re-open until July at the earliest. There is also a worry that even when it is allowed to open again, the combination of a weakened economy and a cautious public will lead to a dramatic fall in earnings over the next few years.

Ripe for a rebound

However, while revenue will clearly take a short-term hit from the ongoing closures, the increase in the number of people flocking to beaches and parks in the last fortnight suggests that there is plenty of pent-up demand for pubs.

Possible changes to the social-distancing rule (the safe gap could be reduced from 2m to 1.5m) and a surge in “staycations” this summer owing to travel restrictions could accelerate the recovery.

Wetherspoon has already doubled since its low in late March, so market confidence appears to be returning already. However, I think the shares have room to rise further.

I recommend going long on Wetherspoon at the current price of 1,114p at £4 per 1p. Put the stop-loss at 850p, compared with IG Index’s minimum of £1 per 1p, for a total downside of £1,056.