JD Wetherspoon still fretting over rising wages

Record sales and cash flow injected some much needed Dutch courage into JD Wetherspoon shares on Friday. That offset concerns over the sustainability of the industry amid tax disparity and the living wage, although the rally has been brief and September's downward trend has resumed.

In his regular request for tax equality between pubs and restaurants, chairman Tim Martin argues that the difference between the three enables supermarkets to subsidise the sale of alcoholic drinks to the detriment of pubs. As VAT has more than doubled to 20% over the last 35 years, pubs have lost 50% of their beer sales to supermarkets.

"Wetherspoon is happy to pay its share of tax and, in this respect, is a major contributor to the economy. In the year under review, we paid total taxes of £632 million, an increase of £32 million, compared with the previous year, which equates to approximately 41.8% of our sales," points out Martin. "This equates to an average payment per pub of £673,000 per annum or £12,900 per week."

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The introduction of the living wage will hit the pub chain, too, as it already pays out 40% of its profits as bonuses. And it's already increased its minimum wage by 5% last October, and by a further 8% in July. In supermarkets, a pint is priced at £1 with staff costs estimated to be around 10p. Compare this to pubs where a (cheap) pint costs £3 with staff costs at 25%.

"By pushing up the cost of wages by a large factor, the government is inevitably putting financial pressure on pubs, many of which have already closed. This financial pressure will be felt most strongly in areas which are less affluent, since the price differential in those areas between pubs and supermarkets is far more important to customers," said Martin

Back to the numbers, and sales rose 7% to a record £1.5 billion in the 52 weeks to 26 July, with like-for-like sales growth of 3.3% driven by food. We already knew the pub chain was struggling to turn improving sales into profits, and increasing staff and utility costs have caused pre-tax profit to fall 2% to £78 million. Earnings per share (EPS) stayed flat at 47p. JD spent £173 million on investment over the year, with the majority being used on either new pubs or extensions to existing buildings. Its IT infrastructure has also been revamped, and over £20 million was spend of freehold reversions.

After paying for pub upgrades, share purchases for employees and interest and tax charges, free cash flow jumped by £17 million to £110 million, reflecting 89.8p per share. Management want to pay shareholders a final dividend of 8p per share, ensuring the total is in line with last year at 12p.

Although Wetherspoon's is unable to firm up its outlook for the year ahead, early trading is in line with the year just gone. Like-for-like sales for the six weeks to 6 September are up by 1.4% and total sales grew 5.2%. It's likely trading has been impacted by wet weather, which has forced broker Investec to lower its sales forecasts for the current year to 1%.

While a larger portfolio of pubs, a better economy and lower interest rates give the group upside potential, higher competition from supermarkets and increasing costs open the scope for downside, too. Investec now expects pre-tax profit of £78.1 million this year, down from £80.1 million, giving earnings per share of 48.2p versus 49.4p previously. That puts the shares on a forward price/earnings (PE) ratio of 15.3 times.

"We have not reflected any possible future efforts to mitigate [higher labour costs], nor the likely improvement in trading from higher disposable income from the introduction of the living wage," writes Investec. It repeats its 'add' recommendation and 800p price target as rising real disposable income should ultimately help trading. On the downside, there's technical support at 675-685p.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.