ShoreCap downgrades JD Wetherspoon to 'sell'

Shore Capital has downgraded pub group JD Wetherspoon to ‘sell’ from ‘hold’, saying the aggressive re-rating beyond past metrics leaves investors exposed should margins not recover towards 10% in the medium term.

The brokerage mentioned that in its pre-close update last July, Wetherspoon delivered a much better than expected margin performance, which has continued into the current year, breaking a long-term downward trend.

The stock re-rated as a result, leaving it trading on multi-year multiple highs, with Shore reckoning the market is now pricing in a recovery in margins to around 10%, which is a level not achieved since FY2010.

“Although we see JDW as a first-rate operator with scope to build margins from current levels, industry headwinds could limit progress. With limited visibility and a high sensitivity to margin development we downgrade.”

Shore noted operating margins have fallen from 10% in FY2010 to just 6.9% in FY2016.

However, second half 2016 margins improved to 7.5% after an exceptionally strong fourth quarter and this has continued into the current year, with first-half margins estimated by management at 8%.

“While H2 FY2017F margins are set to fall our full year estimate of 7.4% appears lowballed, although a rising freehold mix/disposals may explain a proportion of the recent improvement.”

At around £2m per pub, Wetherspoon is valued at a near two-decade high despite profit per pub being unchanged over the period. This is reflected in a free cash flow yield approaching a low of 7% despite only a modest new build programme, low returns and the balance unlikely to provide such a favourable tailwind as in the past.

“We believe the market is now pricing in a recovery in margins to 10%.

“We believe that the aggressive re-rating beyond past metrics leaves investors exposed should margins not recover towards 10% in the medium term. Should margins fail to build from current levels, fair value could be circa 650p per share."

At 1008 GMT, the shares were down 3% to 959.50p.