JD Wetherspoon PLC is a UK based company involved in the development and management of public houses in the UK (REUTERS). The company is listed on the London Stock Exchange and operates its business through 793 pubs all over the UK (WETHERSPOON). It provides food and a variety of alcoholic and non alcoholic drinks to its customers at competitive prices. Wetherspoon is known for its cheap drinks and food promotions. It also focuses heavily on its breakfast and coffee menus.
In addition to traditional pubs, the company also operates newer styled bars providing a more vibrant and contemporary atmosphere under the ‘Lloyds No 1’ brand name. It also operates a relatively new hotel chain consisting of 16 hotels.
Wetherspoon was founded by Tim Martin in 1979 with the first pub in London. In its early days, the company grew by opening pubs in unusual former retail locations. Over the 80s the company differentiated itself from other pubs by ridding itself of music, television and games and thus created a unique identity. In 1992 it was listed on the London Stock Exchange as a UK wide chain of around 40 pubs. Going public, provided wetherspoon with the required funding to expand and within the next four years the number of pubs in the chain quadrupled to 160. In the late 90s, the company diversified into the lodging business which still represents a very small proportion of their revenues. Over the past ten years wetherspoon has continued to expand and has successfully established a reputable network of pubs throughout the U.K.
This report focuses on critically analysing JD wetherspoon’s strategic, financial and stock market performance over the past five years in comparison with its competitors and the industry as a whole. In conclusion the report will attempt to make recommendations to a potential investor regarding potential in the company.
Strategic Analysis
Pubs lie at the heart of British life and culture. Going to pubs has been one of the primary sources of entertainment in the country. According to the Social Issues Research Center (SIRC), an Oxford based not for profit social research organisation, over 75% of the adult British Population goes to pubs and over a third are regulars who go to pubs at least once a week (SIRC). This represents an industry with a customer base of roughly 37 million people.
Broad business environment
The broad business environment in the UK has changed drastically over the last decade. There have been about 300 pieces of government regulation in the public house sector along with tax increases, smoking ban, and changes in consumer lifestyles and attitudes towards going out and drinking. Pubs have needed to change with the times in order to retain their margins and remain profitable. Those successful have adopted an active strategy of evolving their business with the changing times.
A detailed PESTEL analysis has been conducted to analyse the broad business environment and its effects on the Pub industry. Please see Appendix A for the full analysis. The most significant factors responsible for shaping the business environment in the pub industry have been discussed below.
Political Factors
The UK pub industry has been highly regulated over the past few years. On the other hand, alcohol duty is rapidly increasing and is many times more than in other European nations. This coupled with the rising VAT and increased government activism against binge drinking and alcohol abuse has made it difficult for the pub operators to operate and maintain their margins.
Economic Factors
The Global economic crisis has led to consumer spending cuts, thereby leading to a decline in pub sales. Moreover rising national minimum wage and aggressive price competition with supermarkets are narrowing pubs’ margins and leading to reduced profits. However government intention to ban sale of below cost alcohol might come as a slight respite to the pub industry.
Social Factors
The rising national concern over Britain’s alcohol habits, have manifested itself in a number of ways. People are beginning to fully understand the problem and the government is taking steps to curb binge drinking and alcohol abuse. The UK drinks industry has launched a huge campaign to address this concern and to make people more aware about the problems associated with irresponsible drinking.
Technological Factors
The advent of technology has changed society’s idea of entertainment, shifting it more inside the confines of the household. This has led to declining public interest in pubs. Pub operators have also increased their investment in technology considerably, in order to enhance the pub experience. These include among others, investments in television systems for sports, electronic point of sale systems and refrigeration systems to store alcohol at precise temperatures.
Environmental Factors
Pub retailers are becoming environmentally conscious and have taken steps to recycle most of the waste products particularly food, in order to reduce the amount of waste going to landfill sites. This is a great opportunity for pubs to portray themselves as socially responsible.
Legal Factors
The Licensing law allowed licensed pubs to potentially open 24 hours a day. This has been a huge opportunity for the pub industry and has increased competition. The law is currently under scrutiny by the government. Any changes to it might have a major impact on the industry. The drink driving laws over the past few years have also been made stringent. This has resulted in consumers avoiding driving to pubs and preferring to drink at home in order to avoid committing a drink driving offence.
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The above factors have had a very profound impact on all the major pub operators. They have responded to the environment and adjusted their strategy in order to succeed in these conditions. There has been a strategic focus on innovation in the pub industry through food development, skills training, interior enhancement etc. With growth in alternative forms of entertainment, socio-political pressures on pub operator margins, and tough economic climate, most of the market players are looking to diversify into the relatively less volatile and high margin businesses.
Industry analysis
With over 50,000 pubs catering to over 35 million customers, the pub sector represents a highly fragmented industry. The industry consists of a few big players with a chain of pubs throughout the UK. The six biggest pub chains own only about 42% of the total number of pubs. The biggest players in the industry by turnover, along with their main brands and number of outlets are as follows.
Source : Mintel – Pub Catering – UK – September 2010
While wetherspoon operates only managed pubs at city centre locations in major towns and cities throughout the UK (MINTEL, 2010), the business models for some of the other major players in the industry are very different and diverse. Punch Taverns operated both leased and managed pubs. Although a major proportion of their business comprises of leased pubs, they still have over 800 managed pubs in the UK. Enterprise Inns on the other hand only operates leased and tenanted pubs.
Greene King has a much more segmented business model wherein its operations are divided into over 2400 managed, leased & tenanted pubs and restaurants, two breweries, and a number of wholesale depots.
Marston’s has a similar mix of activities with over 2100 managed and tenanted pubs and bars, five breweries and wholesale facilities. Mitchells and Butlers (M&B) operates managed pubs and pub restaurants mainly in the UK, but also has a small number of pub restaurants (43) in Germany. A very small proportion of their total estate consists of leased and franchised sites. They are the largest operator of managed pubs with over 1800 managed pubs in the UK.
Competition for the smaller 58% of the pubs is largely limited to players in the local market. For example – an individual pub in Leeds only competed with other individual pubs in Leeds. In order to analyse the pub industry in detail a full analysis has been conducted based on Porter’s five forces framework (Appendix B). The major outcomes of the analysis are as follows
Threat of Entry
Starting up a pub is reasonably easy process due to an undifferentiated market, and fairly low set up costs. Obtaining the individual pub license is fairly straightforward. Besides easy access to supply channels and low cost capital, have led to a significant threat of entry.
However, a large scale of operations, popular brand identity, experience in the industry and established distribution channels are essential to operate competitively in the industry. Moreover increased government legislation and extraordinary levels of taxation in the sector have made it unattractive to new entrants, thus restricting the threat of entry to some extent.
Threat of Substitutes
Supermarkets, restaurants, hotels and off licensing shops represent a group of substitutes to public houses. Supermarkets in particular enjoy huge economies of scale and are in a position to undercut pub-prices.
The perceived performance to price ratio to the consumer defines their choice between pubs and their substitutes. Although supermarkets cannot replicate the value added services provided by pubs, with the global financial crisis affecting disposable incomes, consumers have become highly price sensitive, thus increasing the threat of substitutes to a moderately high level.
Bargaining power of buyers
Buyer’s bargaining power has traditionally been moderately high due to low switching costs and easy availability alternatives. Recent trends categorised by declining alcohol consumption, low consumer disposable incomes, consumer preferences of drinking at home have further increased buyers’ power.
Bargaining powers of suppliers
The bargaining power of suppliers is quite high as the industry due to the dominance of a concentrated group of suppliers. A number of suppliers own powerful brands and hence pubs have to buy from them in order to satisfy consumer demands. Moreover, supply agreements such as tied house contracts give the suppliers an upper hand. The high power suppliers mean that pub operators, who have their own breweries and wholesale depots, have an obvious advantage.
Competitive Rivalry
The industry has traditionally been a growth industry with most major players looking to expand and open more pubs. However, pub margins have declined over the years and large volumes have become increasingly critical for pub companies to survive. The threat of competition from supermarkets has also become significant and combined with moderately high threat of entry, and strong bargaining power of customers, has led to increasing levels of competitive rivalry.
The industry is categorised by low levels of product differentiation and aggressive price wars between competitors. The declining alcohol consumption, sluggish market growth, high taxes and pub closure rates have resulted in aggressive competition for retaining revenues.
The pub industry is in a state of consolidation. The business environment has been tough and falling margins has made it difficult for pubs to meet their costs. With pub closure rates having reached record levels in 2009; all the major pub chains are in the process of reviewing and reorganising their business in order to adapt to the changing conditions.
Wetherspoon’s Strategy
Wetherspoon has adhered to simple principles of cleanliness, cheap drinks and good value food. With no music, wetherspoon pubs are seen as places where people can interact with friends over a round of drinks or food. The principle strategy that separates wetherspoon from most of its competitors is its focus on the consumer. Whilst a number of competitors lease their pubs out and are therefore less concerned about the ultimate consumer, wetherspoon makes constant efforts to innovate and enhance the consumer experience. This has given them the competitive edge over their competitors and hence they have chosen to stick to the 100% managed pubs business model.
Wetherspoon has traditionally been quick to foresee impending changes in the business environment and strategise in order to adapt. They have stuck to their low price high revenue pricing strategy. Their efforts to provide products at the lowest price possible has been considerable success in recent times as customers have become highly price sensitive and are looking for ‘value for money’. They expect their promotions to remain a key driver to high revenues.
Wetherspoon is aiming at rapid organic and inorganic growth by opening up new pubs and developing and refurbishing the existing ones. The economic downturn has provided it with the perfect opportunity to expand given low property prices and continued profitability of their pubs. Wetherspoon plans to open 250 new pubs in the period 2009 – 2014 (RICHARD WACHMAN, 2009). Their expansion strategy involves taking over underperforming bargain pubs and turning them around to profitability. The company rents most its pubs as opposed to buying them in a bid to keep its debt levels low. This has approach has enabled them to reach a position where they have considerable amounts of money to invest whilst their competitors are finding it very difficult to service their rising debts.
Wetherspoon is focussing on developing their high margin food and coffee business. Wetherspoon started opening their pubs at 7A.M. to capitalise on early morning coffee and breakfast demand. This has also led to increase in overhead costs but having been rewarded with a 40% increase in coffee and breakfast sales, wetherspoon will continue to focus on the diversified product mix to stabilise and improve their overall margins.
The company have invested significantly towards improving their service and standards. They have focussed on personnel and training and are making efforts to enhance customer experience in order to further boost the value provided for the money they charge their customers. Their strategy involves a number of efforts to portray themselves as a responsible business by taking on ethical business practices such as proper implementation of Challenge 21, conserving resources, recycling waste and reducing energy consumption.
Wetherspoon’s chairman, Tim Martin owns around 23% of the company. This helps to reduce agency costs as the objectives of owners and management are likely to be more closely aligned. His 31 year long experience in the industry gives wetherspoon a strategic advantage over its competitors. The company’s CEO John Hutson, has also been with the company for more than 20 years.
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There have been a few problems with the company’s management in the past, most significantly the technical breach of the Companies Act 2006 in 2008, when the company failed to file the interim accounts with the registrar of companies prior to paying the 2007 final dividend and repurchasing its shares from the market (JD WETHERSPOON, 2008). Such incidents lead to financial and reputational losses and dent the public image of the firm.
More recently, the unexpected resignations of the company’s finance director Keith Down and its cheif operating officer Paul Harbottle have raised concerns about the managerial longevity of its board of directors.
Financial Statement Analysis
This section will analyse wetherspoon’s financial performance over the past five years as compared to its competitors and the industry in general. Of the competitors identified in the above section, Mitchells & Butlers and Punch Taverns have a more similar business model to wetherspoon and hence their performance has extensively been used as a benchmark in this section.
Year
2009-10
2008-09
2007-08
2006-07
2005-06
Revenues (£million)
996.33
955.12
907.50
888.47
847.52
Table: Wetherspoon’s revenues for the past five years
Turnover and Profitability
Wetherspoon has experienced consistent growth in revenues over the past decade. Rebasing the revenue at the 2006 levels, wetherspoon seem to have outperformed most of the competition in terms of revenue. Although its revenue growth is one of the highest in the industry, it is still far behind Mitchells & Butlers and Punch Taverns in absolute sales numbers.
A significant proportion of Wetherspoon’s revenue comes from its new pubs. Over the past few years absolute revenues from new pubs has remarkably increased with wetherspoon opening more pubs year by year. In 2010, an extraordinary 97.68% of the growth in revenues was attributable to revenues from new pubs while like for like sales only accounted for 2.38% of the revenue growth. This is up from new pubs contributing 77.13% of revenue growth in 2009 and 57% in 2006. This indicates saturation in the revenue capacity of the already established pubs and exemplifies the importance of wetherspoon’s growth strategy to its revenues.
Wetherspoon’s cost of sales (COS) is the highest amidst the competitors. Over the past five years, the wetherspoon’s average COS has been over 80% of revenue. This combined with other operating costs leads to an average operating profit of just under 10%. This is considerably low, compared to its competitors specially Enterprise Inns which has an average operating profit of over 55% in the 5 year period. The big difference in operating profit is to a large extent representative of the differences in business models of these companies. As JD Wetherspoon operates managed pubs only, the cost of retail sales is significant. On the other hand, the revenues of some of the competitors like Enterprise Inn’s, Marston’s and Greene King are composed of the less costly rent, lease receipts and proceeds from the wholesale sales from their breweries and other alcohol manufacturing facilities. Since wetherspoon’s activities are more direct cost intensive, the higher cost of sales is understandable.
A unique factor which distinguishes wetherspoon from its competitors is the low and stable debt interest levels. Wetherspoon’s interest expenses on debt were lower by over 210 million as compared to Punch Taverns for the financial year 2009-10. Besides lower levels of total debt, a low effective weighted average rate of interest on debt has contributed to the smaller interest charge. While wetherspoon are able to borrow at an average of 5.47%, the weighted average interest on debt for Punch Taverns in 6.8% on secured loan notes and 6.5% on finance leases. This is either due to relatively good swap management of interest rate, a safer credit profile, or lower principle amount and maturity period of the loans.
This gives wetherspoon a big competitive advantage and enables them to retain a sizeable proportion of their operating profit as Net profit. Excluding the interest charge, Punch Tavern’s net profit would have been higher than that of wetherspoon. This illustrates the real impact of interest on debt on the relative profitability of these firms.
Wetherspoon’s exceptional items solely comprised of impairment of property and fixed assets and amounted to 10.6 million this year. This represents a steep reduction of 47% from last year’s figure of 19.9 million and is primarily attributed to no litigation costs and property related write downs.
Wetherspoon’s net profit has been very consistent over the past few years as opposed to its competitors. The tough global economic climate and the hostile business environment in the pub sector have led to a sizeable decline in profits for both Punch Taverns and Mitchell and Butlers. On the other hand wetherspoon’s consistent growth in revenue combined with low relative impairment losses and interest on debt has enabled it to maintain a profit of 40.78 million in 2010. This is a 61% rise from its profits in 2009. This compared with losses of 84 million and 159.90 million from Mitchells & Butlers and Punch Taverns, reflects an overall superior performance by wetherspoon in terms of profitability.
As per the chart above, wetherspoon’s return on assets and return on capital invested are immensely higher than both of its competitors. The two ratios rose 37.42% and 48.78% respectively from their 2009 levels. These jumps are primarily because of the 61% jump in earnings and represents excellent management of resources by the company’s management.
Wetherspoon rents a majority of its pubs and hence has a low level of noncurrent assets. This is the primary reason for the high asset turnover and return on assets. Wetherspoon’s revenues are 1.12 times of their total assets as opposed to Punch Tavern’s 0.22. This astoundingly high ratio represents wetherspoon’s highly competitive pricing strategy and its low margin, high volume operations. Wetherspoon’s ability to extract over 3-4 times more revenue than its competitors, gives it a clear competitive edge.
Liquidity
A majority of the assets in pub businesses tend to be non-current and hence the short term liquidity ratios tend to be lower. Moreover since the current assets in managed and operated pubs are mostly cash and other very liquid items, slightly lower current ratios are not deemed to be very risky. Wetherspoon’s current ratio of 0.37 is amongst the lowest in the industry. This has been fairly stable over the past five years with a standard deviation of a mere 0.064. Mitchell and Butlers’ and Punch Taverns have much higher current ratio of 0.64 and 1.27 respectively. Similarly, Wetherspoon’s quick ratio of 0.18 is nearly a fifth of Punch Tavern’s ratio.
Wetherspoon’s current and quick ratios are both the lowest and the most stable in the industry with standard deviations of 0.064 and 0.036 respectively. The incredible stability of the ratio indicates a strategic approach to business operations. Very low liquidity ratios generally mean trouble for businesses, as they are indicators of inability to honour short term obligations. Theoretically, if all the current liabilities need to be paid off, wetherspoon will not have to resort to selling its fixed assets in order to arrange for the payment.
However, cash payments from its customers along with favourable and stable credit terms with suppliers ensure that wetherspoon are able to manage will low current and quick ratios. They attempt to keep the current ratio at a reasonably low level in order to extracts maximum value from their current assets. Nevertheless, a current ratio of 0.37 is too low compared to the competitors and hence liquidity issues are more likely.
Punch Taverns’ liquidity ratios are a lot higher primarily due to a high amount of receivables mainly caused by its leased and rented pub business. In those businesses, punch taverns’ tenants are likely to have a payment period within which they can settle the rent/lease payments. This leads to a significant amount of trade receivables. On the other hand almost all of wetherspoon’s revenues are retail cash revenues and hence the receivables are either due to prepayments or accrued income
Wetherspoon’s receivables are only about 10 of Punch Taverns’ which it converts into cash within 1.64 days. This is many times lower than its competitors. Moreover inventories held days is a mere 8.5 days representing a quick and highly efficient cash cycle.
Gearing
Wetherspoon’s business model of operating with low level of debt is quite unique in the pub industry. The company enjoys the lowest level of long term debt amidst its competitors. Wetherspoon’s long term debt of 411.64 million is just 8.6% of that of Punch Tavern’s. M&B and Punch Taverns on the other hand have debts of over 2 billion pounds.
A low level of debt despite an active growth strategy and a consistent rise in its plant property and equipment (PPE) is a rare phenomenon. Wetherspoon’s managed to make this happen by renting quite a few of its pubs and managing debt efficiently.
The extraordinarily low levels of debt at wetherspoon are matched by an almost equally low relative level of common equity. As a result wetherspoon’s Debt equity ratio is not as different from its competitors. Wetherspoon’s total debts are 2.56 times its equity as compared to 2.89 for Mitchells & Butlers and 2.42 for Punch Taverns.
The ratio used to be 1.83 in 2006, before the company initiated massive share repurchase programme which was largely financed by additional debt.
As per the above table, their Total Debt to Earnings before interest and tax ratio has been the lowest in the industry. Over the years, as other companies have taken more debt relative to their earnings, wetherspoon has continued to utilise its debt with the same efficiency in order to generate earnings.
Dividends
Wetherspoon’s dividend payout ratio is incredibly high for a company which is in the growth stage of its lifecycle. In 2010 wetherspoon paid 64.19% of its net income as dividends. This represents a 292% jump from the 2006 dividend payout and is the highest in the industry. While Mitchells & Butlers and Punch Taverns haven’t paid dividends in the past two years, wetherspoon has continued to pay dividends at an average of about 39% of their net profit in the past 5 years.
Wetherspoon declared a yearlong dividend freeze in during the financial year 2008-09 in order to direct its cash flows towards debt reduction. The freeze was ended in March 2010 once the new 530 million banking facility was renegotiated. Now with the financing issues sorted, a progressive dividend policy can be expected from wetherspoon’s management as a measure to signal a bullish future outlook.
Cash Flow Analysis
In 2009, the pub industry experienced a sharp decline in cash flow as most of the players make efforts to deleverage themselves post the credit crunch. Wetherspoon’s went from being a cash generator of 7.15 million in 2007 to a cash sink of 2.6 million in 2008. The financing outflows jumped threefolds mainly due to dividend payments of 17.38 million and repurchases of one million shares from the market. The net cash flow continued to be negative in 2009 primarily due to the repayment of long term debts to the tune of around 45 million pounds. Since then the cash position of the company has recovered and the company was a cash generator of 2.48 million in 2010.
Wetherspoon’s has a positive growth in cash inflow from operating activities, but the overall level of operating inflow is low. While Punch Tavern’s operating inflows are declining due to dwindling revenue and profits, Mitchells and Butlers in contrast, enjoy a much better cash flow from operating activities and hence has access to a bigger pool of funds for its investing and financing activities.
Wetherspoon’s growth policy has led to increased cash outflows from investing activities by over twice the amount in 2006. On the contrary Mitchells & Butlers has decreased their cash outflows in investing activities. This is due to their strategic sale of a number of pubs in order to concentrate on the high margin food business.
Wetherspoon’s repayment of the USD 140 million private placement was accompanied by a further advancedment of 96.68 million pounds of long term loans. As a result the cash outflow from financing activities decreased significantly from last year. The total cash flow position would have been much worse, if the company hadn’t put a freeze on dividends in 2009. Wetherspoon’s decision to not declare a final dividend for the financial year 2008-2009 ensured prevented a further cash deficit, given the high levels of capital expenditure in 2009.
Accounting policies and Problems in Comparison
Given the immaterial size of the companies hotel business, and no international operations, wetherspoon doesn’t split its results by business or geographical segments in accordance with the IAS 14.
Wetherspoon follows a historic cost model and does not revalue its non current assets. Punch Taverns follow the same method, however Mitchells and Butlers actively revalue its assets. This can lead to distortions in actual value of non current assets and makes them uncomparable. For example – Wetherspoon unlike Mitchells & Butlers ignores the effect of inflation on the value of its assets.
While wetherspoon depreciates fixtures and fittings over a time period of 3-10 years, Mitchells and Butlers do it over a period of 3-20 years. This can further make the asset values uncomparable.
Stock Market Analysis
The FTSE 350 index seems to be very highly correlated to the FTSE 350 Travel and Leisure index. Prior to the subprime crisis, the travel and leisure index seems to be doing marginally better, while post crisis, the FTSE 350 has slightly outperformed the FTSE 350 travel and leisure index.
JD Wetherspoon has outperformed both the indices almost all the time during the last 5 years except for a brief period in 2008 because of the immediate effect of the economic crisis.
As per the above graph, JD wetherspoon has consistently outperformed Punch Taverns throughout the past five years. It has also better than Mitchells & Butlers since the middle of 2008. This is primarily due to relatively higher revenues and profits at wetherspoon. Wetherspoon’s expansion strategy has enhanced its future outlook and given a boost to the company’s share price.
January 06 – March 07
The period from Jan 2006 until the beginning of 2007 saw a very sharp increase in wetherspoon’s share price. While the travel and leisure index only rose up by around 25%, wetherspoon rose by a phenomenal 120%. The football world cup kick-started the 8 month long rally in the travel & leisure index. Wetherspoon took advantage of the opportunity by abandoning its ‘no television’ policy and showing the matches in its pubs. Moreover, they also started to establish a very strong foothold in the coffee and breakfast market. Besides strong financial performance in 2006, wetherspoon’s purchase of 800,000 of its own shares in September 2006 (REUTERS, 2006) , the interest of Schroder Investment Management in 12.05% of its total common shares, along with significant interests from Aegon UK and Global Value fund Sicav, were one of the primary reasons why wetherspoon’s rose to its all time high level of 761 pence in March 2007.
April 07 – September 2008
The smoking ban was implemented in the UK with effect from July 2007. As expected, the ban put immense downward pressures on pub revenues, thereby leading to a crash in share prices. The travel and leisure index crashed around 30% by the end of the year and wetherspoon lost 50% of its value. 2008 presented even worse economic conditions for the pub industry with the advent of the credit crisis. All major pub operators continued to face loss of revenues and hence saw a significant decline in their share price. The extreme volatility in credit markets forced Mitchells & Butlers to shelve a 4.5 billion pound property deal (BLAND, Ben, 2007) leading to losses of 274 million pounds on hedges tied to the transaction. Moreover, failed efforts by Punch Taverns to acquire Mitchells & Butlers, led to further decline in share prices of both companies. On the other hand Wetherspoon continued to strengthen its revenues due to increased revenues in its food business. In September 2008, wetherspoon declared a 5.5% increase in sales and a 12p per share dividend as opposed to zero dividends and huge losses by punch taverns. As a result wetherspoon’s share price started to consolidate and by the end of
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