Tue 4th Nov 2014 - Analyst – JD Wetherspoon has a troubling dynamic Analyst – JD Wetherspoon has a troubling dynamic: Simon French, leisure analyst at Cenkos, has issued a sell note on JD Wetherspoon, arguing the company ‘has a troubling dynamic’. French stated: “Wetherspoon has spent £608m of capex in five years but operating profit is only £19m higher. The group has successfully repositioned its offering with food at the centre enabling it to win market share but margins have fallen 184bps despite a circa 18% increase in like-for-like sales over the past four years. However, as its customers’ real incomes rise we expect them to trade up to casual dining units. Adjusted net debt/Ebitdar is high at 4.7x and we think management needs to conserve cash, not spend it on 30-40 new sites per annum. We see more risk to the investment case than for some years and despite the relatively inexpensive valuation we initiate coverage with a Sell recommendation. The group has spent £608m of capex in five years and profits have increased from £97.0m in FY 2009 to £115.6m in FY 2014. Over 2009-13 the group has opened 205 new sites, which should have added circa £26m of profits. If they have, then like-for-like profit must have fallen by circa 8% despite up to £150m refurbishment capital. Over FY 2010-14 Ebit, margin declined 184bps despite like-for-like sales rising c18%. We believe much of Wetherspoons recent like-for-like sales growth has been unprofitable but we see no sign of the sales-led strategy changing; indeed with no finance director, margin erosion could accelerate. Wetherspoon is often considered to have one of the stronger balance sheets amongst the pub companies. We disagree and would highlight adjusted net debt/Ebitdar of 4.7x as higher than Greene King and Mitchells & Butlers to support this view. This raises concerns over the sustainability of the new pub opening programme, dividend policy and share buybacks. Put simply we think the group should focus more on conserving its cash and making its existing operations more profitable. Management says new openings continue to perform well but CROCCE continues to fall. Implicitly therefore returns from existing pubs must be trending downwards. The stock isn’t expensive trading on a CY 2015E adjusted EV/Ebitdar of 7.8x although the EV/Ebit of 13.0x and the P/E of 15.2x are amongst the highest in the sector. Forecast three-year CAGR in EPS of c12% is also attractive and the highest in the sector but helped by expensive interest rate swaps rolling off. We see more risk to the investment case than for some years and initiate coverage with a Sell recommendation.”