May 2022: J D Wetherspoon – Show me the money + Scratched records

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JD Wetherspoon – Show me the money + Scratched records 

May 2022 (718p)

 

The essence of our assessment of this company changes little because neither does the company’s business model. The only reason for our numerous comments over the last twelve months is due to the mispricing of the shares which we feel has been ongoing. Post a call with management following yesterday’s Q3 trading statement we add a few new comments below. These are far less about current trading and more an updated assessment on the company’s business model & outlook. Those unfamiliar with our JDW work we would recommend reading our Walton on Thames and Modelling Spoons pieces.

Scratched record

Recently we observed the following about JDW:

Whilst we of course see and accept the uncertainties around the cost of living and how that can affect discretionary expenditure like eating/and drinking out we are comforted by the fact that those with genuine low-price offerings (such as Greggs or JDW) have:

  • A huge ability to protect their profits if they chose to do so with small price increases
  • Are by far the lowest price providers for what they do, so are postponed well from any trading down that will occur
  • Have weathered many different cost of living environments during their long periods as listed companies Source: Holland Views: JDW March 2022

Since we wrote those words the company has released its interim results and now also its Q3 trading statement. Pleasingly for those of us that enjoy playing our scratched records (i.e. re-iterating how attractive this company’s shares look) the management team very much echoed points 2+3 above in their comments. On point one JDW Management are always very coy, often choosing to evade talking about prices whenever possible. Your author however realising that pricing is the key differentiator of this company from its peers often pushes for insights on this issue.

Pricing power and pricing gaps

Yesterday JDW confirmed that they put up bar prices in March by 2%. Also, food prices in April by 8-10%. The latter sounds a lot, but we must remember this includes the Government re-introduction the full VAT rate on food (i.e. back to 20% from 12.5%). Those that might not frequent ‘Spoons’ may not know that they passed the Covid VAT cut to customers in full during the pandemic when it took place. Almost all other pub/eating out companies did not-instead pocketing the difference straight to profits. The differing effect of these respective actions on profitability to the sector and JDW was huge and should not be underestimated. However, that prices have now risen just a little above the required VAT increases shows to some, that JDW is not just being run for its customers. Also, for shareholders too! I.e. that in the face of a pandemic recovery and some cost pressure the company is prepared to make small rises in prices.

Crucially for our assessment of the company however we note that the gap with restaurant and pub peers gave JDW ample room to do this. We want readers to note that a 2% rise or cut in prices alone (i.e. assuming no other changes in volume and /or cost inflation) would swing JDW net profits by c.40 % in a year. This assumes a starting 4% net margin on £1.8bn of sales (i.e. where the company was trading in 2019, the full year before CV-19). As an ardent Wal-Mart follower and excellent scale economy shared business sneaking extra price rises through in order to make a little more short-term profit is not in JDW’s DNA. Indeed, we would recommend the video below to any that have not listened to it. It is Tim Martin talking about a trading period where they could have avoided a past profit warning just by putting a few pence on beer prices – he chose not to do so. We think it is enlightening as to the company’s culture not just towards pricing, but also on important areas like long-term staff and customer loyalty also. https://vimeo.com/305746906

When asking a little more about pricing yesterday the company was happy to tell us something we already knew, but were delighted to have confirmed. This being that the pricing gap with its pub peers is likely at the biggest gap it has ever been. With the VAT actions others took during CV-19 (i.e. they all kept it) and with other pub/restaurant price increases we also have seen, this fact was anecdotally clear to us (and our sons!). That said it was still good to hear the company call it out. In the past when looked at over a basket of food and drinks JDW was c.20-30% cheaper than its nearest peers. As to what that gap is today, we do not know apart from to say it is “bigger”, maybe “much bigger”. Another fact to consider as the company has pointed out to us before is the following. I.e. that the basket checks the company does occasionally to estimate this gap is done by each pub manager. They assess the pricing of different food and drinks in the pubs and bars nearby which they compete with. But most pubs trading near a Wetherspoon have to be price conscious to survive. This has always suggested to us that the gap with the wider industry (including a pub say 10 miles away is likely even greater still).

Inches and chasms

A few years back your author spent a little too much time looking at the UK food retail sector. Much as he learnt a lot, he also learnt about places he did not want to fish. This experience led to Holland having a new mental model to add to our list:

“Avoid the trenches – i.e. businesses where you have to fight 24/7 to win 6 inches of no-man’s land, only to give it back the next day.” Source: Holland Advisors

This tries to encapsulate those industries where the pricing differences are very small and very hard to gain any sort of real lasting dominance in. What has always interested us about JDW vs say a supermarket company is that like a lot of successful scale-economy businesses it is the only player in its field operating with this model (i.e. in the UK/Irish pub sector). Also, that the pricing difference between it and is peers is not small and hard to see, but huge, and therefore most importantly obvious to the consumer.

There is only one boss. The customer. And he can fire everybody in the company from the Chairman on down, simply by spending his money somewhere else.” Sam Walton, Wal-Mart founder

In our Walton on Thames piece, we spent some time considering the true moat of JDW. We did this using an approach that Buffett himself once used to look at Geico.

We looked at what was given back to customers, employees and shareholders over time to make each of them happy/better off. We were then delighted when no less than Jeff Bezos used exactly the same methodology to assess his time at Amazon in his last annual letter a few months later…

Hypotheticals

The benefits that have accrued to each group are laid out in our Walton on Thames report. However, a short cut could be to consider what the profits of JDW might be today were the pricing gap with peers not c.30%+ as it likely is today, but only c.20%. Using the price sensitivity calculation, we made above we can adjust for prices being 10% higher, not 2% higher. This suggests that 2019 profits after-tax might have been £216m vs the £72m they were reported at! Today market cap just for a recap is £920m. We note the staff cost inflation that has been prevalent in this sector for the last 5+ years would have given this company ample reason to have such a pricing architecture if it had chosen to. Also, its customers would have still enjoyed much lower prices than anywhere else where they could have eaten/drunk out at. finally, such a large profit of £216m vs £72m would have been a Net Margin of c.12%, ie similar to Youngs!

Were those profits to have been reported, we suggest that Tim Martin might be looked at somewhat differently by our friends in other finance jobs! JDW would still be a powerful leading-on-price company, but in the customers’ eyes maybe not quite as powerful as it is seen as today. Indeed, likely its volumes might have been a tad lower as a result, reducing a little the net profit figure we just guesstimated above. JDW however chose not to do this.

DNA

Reflecting on this hypothetical scenario we are reminded of some reading we did around Costco some years ago, particularly the language of Sol Price and Jim Sinegal. Costco customer centricity was just so ingrained in its DNA that it stopped any shorter-term opportunities to profit at the customer’s expense. By always using a mark-up of only 14% made on any item it sold, this stopped a buyer who had secured 100,000 pairs of jeans for $10 each marking them up to anything other than $14, even when they knew the customer would be delighted to pay $25 for them.

Sadly, for us city scribblers, JDW has never given an easy rule of thumb around mark-up or another metric that makes the company easier to forecast. That said its long-term commitment to low prices, even in the face of lasting cost pressures is a true testament to its genuine long-term customer focus. It shows an ingrained deferred gratification gene. Investors should note just how rare this trait is. Tim Martin is often characterised in the press for one reason or other, but his desire to challenge consensus thinking and frankly his stubbornness is the exact trait needed from such-scale-economy shared founder managers. We read the motto below recently:

“You don’t go into value investing for the group hugs” Source: Anon

The same we suggest is true for these types of super long-term deferred-gratification business models.

“Show me the money”

Those that want greater insights into the more detailed drivers of JDW current trading and outlook should look at two PDF’s we attach. They have been helpfully distributed by the company’s Finance Director and outline questions that arose during two periods of investor meetings. Also, giving the company’s answers.

Most observers will have by now read that JDW’s most recent weeks trading is now back to fiscal year 2019 level. Whilst the company has spoken to cost inflation being contained at JDW due to high freehold ownership, leases with limited uplifts + good staff retention, the company have accepted there are some cost pressures.

The company has also now spoken of expecting a “normalisation” of profits in the coming financial year (i.e. to July 23). This profit recovery was clarified by JDW’s management as likely to need turnover of c. £1.97bn (i.e. 8.3% above that in fiscal 2019) due to cost/other inflation. Mr Market’s lack of reaction to this prospect of a full profit recovery is notable. We suspect with all that has gone on in the last few years and the slow trading recovery JDW has made vs other pubs thus far, this c.+8% caveat is just too much of a leap of faith. When once Mr Market was able to look past the Covid trough, discounting an expected recovery for companies like JDW, now he is in a tired Gerry Macquire mood, i.e. I will only believe all this when you … “show me the money.”

For that reason, the investment return prospects are excellent for those prepared to take a long-term view on JDW’s customer proposition and its likely continuing growth and dominance of it.

Super-models

The time we spend modelling companies is mostly just to understand likely earnings power. It is not be accurate in any short-term outlook. The piece we wrote in December (Modelling Spoons) and the spreadsheet that accompanied it are re-attached (with no changes). At that time assuming a return to 2019 sales levels might have seemed optimistic, now this seems once again realistic. Indeed, our June 2023 sales estimate was £1.93bn, vs company guide now of c.£1.97bn – not a bad guess maybe! That the company needs 8% higher sales in order to remake 2019 profits may cause concern for some observers, not for us. This is for a number of reasons:

  • In January 2020, just before Covid struck JDW had just reported LFL sales growth of 5% above the 2019 year. This implies the group only needs to return to pre-Covid trading
  • The sensitivity we have shown to pricing is illustrative of what the company can do to pass on cost inflation if it needs to. Whilst the company did not disclose the price/volume component of the c.8% rise in sales needed we suspect this is currently all volume.
  • This company’s value proposition pre-Covid was exceptional and drinkers and diners knew it hence the multiyear LFL sales growth they enjoyed up until that point. The price for product/service gap with peers has leapt to a chasm during the Covid years. Whilst there is as yet not the evidence to prove it, we stand by the view that JDW during Covid was a Mo Farah stock. By that we mean i.e. it will turn out to be a market-share winner at competitors expense.
  • All of this points to consistent likely good LFL sales being reported in future normal years to come

Another quick look at our December model gives the following conclusion, notably from a then starting price of 911p:

  • We made the best guesses we could about future growth and its likely investment cost whilst also assuming a gradual rise to 10% margins in year seven. This margin rise is not price gouging but just the effect of greater scale throughput using existing well-invested pub assets. The result of this was a 7year investor IRR of 25%. With a £43 share price in June 2029.
  • Even keeping margins constant over the whole forecast period gave a 15% IRR

Reducing our start price to £720p increases these returns to 26% and 17%pa respectively. These are extraordinary potential returns from a proven low-cost producer business that your 21-year-old children can tell you will be a winner.

Easy to say – Hard to do

For many years now we have used the following Venn diagram in marketing and research pieces. We think it shows investing as its simplest. We also think it shows exactly what Buffett has been doing for the last 80 odd years, I.e. buying great business when they were not priced as such (e.g. Coke/Amex/Apple).

Fig.1 Buy, when great companies are price like bad ones:

 

Identifying great powerful, resilient businesses with good compounding prospects when all around you have written them-off we don’t think is easy to do psychologically. However, that is what we think todays JD Wetherspoon opportunity is for those prepared to do the work. As Munger opines:

“if it was easy, everyone would be rich”

Buy JD Wetherspoon

*Any estimates on the future of the company returns are the view of the author only. These should not be used as forecasts or recommendations.

Andrew Hollingworth

The Directors and employees of Holland Advisors may have a beneficial interest in some of the companies mentioned in this report via holdings in a fund that they also act as managers to.

 

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This document does not consist of investment research as it has not been prepared in accordance with UK legal requirements designed to promote the independence of investment research. Therefore even if it contains a research recommendation it should be treated as a marketing communication and as such will be fair, clear and not misleading in line with Financial Conduct Authority rules. Holland Advisors is authorised and regulated by the Financial Conduct Authority. This presentation is intended for institutional investors and high net worth experienced investors who understand the risks involved with the investment being promoted within this document. This communication should not be distributed to anyone other than the intended recipients and should not be relied upon by retail clients (as defined by Financial Conduct Authority). This communication is being supplied to you solely for your information and may not be reproduced, re-distributed or passed to any other person or published in whole or in part for any purpose. This communication is provided for information purposes only and should not be regarded as an offer or solicitation to buy or sell any security or other financial instrument. Any opinions cited in this communication are subject to change without notice. This communication is not a personal recommendation to you. Holland Advisors takes all reasonable care to ensure that the information is accurate and complete; however no warranty, representation, or undertaking is given that it is free from inaccuracies or omissions. This communication is based on and contains current public information, data, opinions, estimates and projections obtained from sources we believe to be reliable. Past performance is not necessarily a guide to future performance. The content of this communication may have been disclosed to the issuer(s) prior to dissemination in order to verify its factual accuracy. Investments in general involve some degree of risk therefore Prospective Investors should be aware that the value of any investment may rise and fall and you may get back less than you invested. Value and income may be adversely affected by exchange rates, interest rates and other factors. The investment discussed in this communication may not be eligible for sale in some states or countries and may not be suitable for all investors. If you are unsure about the suitability of this investment given your financial objectives, resources and risk appetite, please contact your financial advisor before taking any further action. This document is for informational purposes only and should not be regarded as an offer or solicitation to buy the securities or other instruments mentioned in it. Holland Advisors and/or its officers, directors and employees may have or take positions in securities or derivatives mentioned in this document (or in any related investment) and may from time to time dispose of any such securities (or instrument). Holland Advisors manage conflicts of interest in regard to this communication internally via their compliance procedures.

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Privacy Notice

This is the privacy notice of Holland Advisors London Ltd our company number is 07431314. Our registered office is at 7 York Road, Woking, Surrey, GU22 7XH.

 

Introduction

This notice describes how we collect, store, transfer and use personal data. It tells you about your privacy rights and how the law protects you.

In the context of the law and this notice, ‘personal data’ is information that clearly identifies you as an individual or which could be used to identify you if combined with other information. Acting in any way on personal data is referred to as ‘processing’.

This notice applies to personal data collected through our website www.hollandadvisors.co.uk.

Except as set out below, we do not share, or sell, or disclose to a third party, any information collected through our website.

 

Data Protection Officer

We have appointed a data protection officer (‘DPO’) who is responsible for ensuring that our privacy policy is followed. If you have any questions about how we process your personal data, including any requests to exercise your legal rights, please contact our DPO, Claire Brunt at  claire@hollandadvisors.co.uk.

 

Personal data we process

1. How we obtain personal data

The information we process about you includes information:

  • you have directly provided to us
  • that we gather from third party databases and service providers
  • as a result of monitoring how you use our website or our services

2. Types of personal data we collect directly

When you use our website, you may provide personal data by submission of data by our Sign Up or Contact Us forms. This can be categorised into the following groups:

  • personal identifiers, such as your first and last names
  • contact information, such as your email address and your telephone number for communication
  • records of communication between us including messages sent through our website, email messages and telephone conversations
  • marketing preferences that tell us what types of marketing you would like to receive

3. Types of personal data we collect from your use of our services

By using our website and our services, we process:

  • technical information about the hardware and the software you use to access our website and use our services, including your Internet Protocol (IP) address, your browser type and version and your device’s operating system
  • usage information, including the frequency you use our services, the pages of our website that you visit, whether you receive messages from us and whether you reply to those messages
  • your preferences to receive marketing from us; how you wish to communicate with us; and responses and actions in relation to your use of our services.

4. Our use of aggregated information

We may aggregate anonymous information such as statistical or demographic data for any purpose. Anonymous information is that which does not identify you as an individual. Aggregated information may be derived from your personal data but is not considered as such in law because it does not reveal your identity.

For example, we may aggregate usage information to assess whether a feature of our website is useful.

However, if we combine or connect aggregated information with your personal data so that it can identify you in any way, we treat the combined information as personal data, and it will be used in accordance with this privacy notice.

5. The bases on which we process information about you

The law requires us to determine under which of six defined bases we process different categories of your personal data, and to notify you of the basis for each category.

If a basis on which we process your personal data is no longer relevant then we shall immediately stop processing your data.

If the basis changes then if required by law we shall notify you of the change and of any new basis under which we have determined that we can continue to process your information.

6. Information we process with your consent

Through certain actions when there is no contractual relationship between us, such as when you browse our website or ask us to provide you more information about our business, you provide your consent to us to process information that may be personal data.

Wherever possible, we aim to obtain your explicit consent to process this information, for example, we ask you to agree to our use of non-essential cookies when you access our website.

We continue to process your information on this basis until you withdraw your consent or it can be reasonably assumed that your consent no longer exists.

You may withdraw your consent at any time by instructing us  claire@hollandadvisors.co.uk.

7. Information we process for the purposes of legitimate interests

We may process information on the basis there is a legitimate interest, either to you or to us, of doing so.

Where we process your information on this basis, we do after having given careful consideration to:

  • whether the same objective could be achieved through other means
  • whether processing (or not processing) might cause you harm
  • whether you would expect us to process your data, and whether you would, in the round, consider it reasonable to do so

For example, we may process your data on this basis for the purposes of:

  • improving our services
  • record-keeping for the proper and necessary administration of our business
  • responding to unsolicited communication from you to which we believe you would expect a response
  • preventing fraudulent use of our services
  • exercising our legal rights, including to detect and prevent fraud and to protect our intellectual property
  • insuring against or obtaining professional advice that is required to manage business risk
  • protecting your interests where we believe we have a duty to do so

 

How and when we process your personal data

8. Your personal data is not shared

We do not share or disclose to a third party, any information collected through our website.

 

Use of information we collect through automated systems

9. Cookies

Cookies are small text files that are placed on your computer’s hard drive by your web browser when you visit a website that uses them. They allow information gathered on one web page to be stored until it is needed for use at a later date.

They are commonly used to provide you with a personalised experience while you browse a website, for example, allowing your preferences to be remembered.

They can also provide core functionality such as security, network management, and accessibility; record how you interact with the website so that the owner can understand how to improve the experience of other visitors.

Some cookies may last for a defined period of time, such as one visit (known as a session), one day or until you close your browser. Others last indefinitely until you delete them.

Your web browser should allow you to delete any cookie you choose. It should also allow you to prevent or limit their use. Your web browser may support a plug-in or add-on that helps you manage which cookies you wish to allow to operate.

The law requires you to give explicit consent for use of any cookies that are not strictly necessary for the operation of a website.

10. Personal identifiers from your browsing activity

Requests by your web browser to our servers for web pages and other content on our website are recorded.

We record information such as your geographical location, your Internet service provider and your IP address. We also record information about the software you are using to browse our website, such as the type of computer or device and the screen resolution.

We use this information in aggregate to assess the popularity of the webpages on our website and how we perform in providing content to you.

 

Other matters

11. Your rights

The law requires us to tell you about your rights and our obligations to you in regard to the processing and control of your personal data.

We do this now, by requesting that you read the information provided at  http://www.knowyourprivacyrights.org

12. Communicating with us

When you contact us, whether by telephone, through our website or by email, we collect the data you have given to us in order to reply with the information you need.

We record your request and our reply in order to increase the efficiency of our business. We may keep personally identifiable information associated with your message, such as your name and email address so as to be able to track our communications with you to provide a high quality service.

13. Complaining

If you are not happy with our privacy policy, or if you have any complaint, then you should tell us.

When we receive a complaint, we record the information you have given to us on the basis of consent. We use that information to resolve your complaint.

14. Retention period

Except as otherwise mentioned in this privacy notice, we keep your personal data only for as long as required by us to provide you with the services you have requested.

15. Compliance with the law

Our privacy policy complies with the law in the United Kingdom, specifically with the Data Protection Act 2018 (the ‘Act’) accordingly incorporating the EU General Data Protection Regulation (‘GDPR’) and the Privacy and Electronic Communications Regulations (‘PECR’).

16. Review of this privacy policy

We shall update this privacy notice from time to time as necessary.