JD Wetherspoon is one of the largest pubcos in Britain, with 880 properties, and had annual turnover last year of ?1.409 billion (Yahoo! Finance, 2015). The company competes with a cost leadership strategy, something that should be reflected on its income statement. It seeks to undercut competitors using its economies of scale in purchasing, and other cost-saving techniques, ranging from zero guaranteed hours for 80% of its workforce to deliver labour cost flexibility (BBC, 2015), to its focus on real ale, which sells at lower price points than lagers. The company is an industry leader, and has been able to win a substantial amount of market share away from both traditional independent pubs and from other pubcos alike, despite operating in a market characterized by intense competition (Aldalou, 2015). This paper will examine the financial performance of JD Wetherspoon over the past five years, along with the performance of Spirit Pubs, formerly known as Punch Taverns' managed estate, one of Wetherspoon's biggest rival amongst corporate pubcos, and fellow member of the FTSE 250.
The Pub Industry
The pub industry in Britain is both large and fragmented. There is intense competition among the existing players. The market's size is estimated to be around ?18 billion by research firm IBIS World (2014), and is shrinking, with an annual growth rate of -0.3%. An estimated 10,000 pubs and bars have closed in the past ten years. Intense competition in the industry led to a situation where many pubs were living off of very slim margins, and declining overall business has forced many such marginal pubs to close. Even among those remaining, competition remains intense and industry observers expect further closures in the coming years. Based on industry size and its current revenues, Wetherspoon holds an approximately7.8% share of the market by revenue, and with 32,500 pubs remaining in the UK, Wetherspoon holds 2.7% of properties. This implies that the company's properties are much more profitable than the average pub in Britain.
Financial Statement Analysis
Despite the dire new surrounding the industry, which is threatened on many fronts including an increase in drinking at home, and declining alcohol consumption in general, Wetherspoon has experienced increased sales over the past five years. The company's revenue growth rate in 2014 was 9.9% in a year when it apparently shed a few pubs from its roster. True to what would be expected from a company on a cost leadership strategy, the gross margin is very slender, at 8.5%, and the net margin is 2.9%. Wetherspoon requires high volumes in order to turn a profit, because they make very little on any given transaction. Yet, horizontal analysis shows that the company is able to turn a profit consistently, despite the overall decline in the industry. Net income has ranged between ?41 million and ?47 million since FY2011.
Further analysis shows that cash flow from operating activities is higher than gross profit, and has held consistent over this time period as well. Last year, cash flow from operating activities was ?144 million, versus ?117 million in 2011. The company's cash flow is higher than profits primarily on account of capital investments, which typically includes real estate purchases and improvements as the company seeks historic properties to acquire and refurbish into pubs.
The balance sheet has also remained stable over the past five years. The company does not carry much cash, and its current ratio does not appear to be particularly healthy, but it has held this ratio for years, steady, indicating that it is able to manage its cash flow effectively. There is a high degree of predictability evidence in Wetherspoon's financial statements As the company has slowly, steadily, grown the level of assets, liabilities and equity have all grown as well. These have maintained roughly the same proportion over time, at 81-82% debt and 18-19% equity (Yahoo Finance, 2015).
The thing that stands out the most in the horizontal analysis of JD Wetherspoon is just how stable the company is. In a sense, it has to be stable, because it operates on such slender margins, but the degree to which every penny is accounted for in this company is exceptional. To be able to maintain an optimal current ratio and an optimal capital structure over the course of several years shows that the management of JD Wetherspoon is excellent, with respect to both its financial management and its operations management.
The other thing that stands out in the horizontal analysis is that Wetherspoon has been able to grow consistently, each year, at a point in time when the pub industry is suffering heavy losses. There is clear evidence as well that Wetherspoon pubs are dramatically outperforming the industry average, given that it holds a much greater share of industry revenue than it holds properties. Each property is, on average more efficient and has a higher turnover, than other pubs. It is entirely possible that this holds both for pubcos and independent pubs.
Spirit Financial Analysis
Spirit is of the bigger pubcos in Britain, with annual revenue in FY 2014 of ?448 million, or roughly a 2.5% share of the market (Yahoo Finance, 2015). This is achieved with 1229 pubs, which is roughly a footprint of 3.7% of pub properties. These results indicate that on average, Spirit pubs are earn less revenue than the industry average, a poor result. Perhaps not surprisingly, this underperformance made the company vulnerable to takeover and in November, 2014 the company agreed to be taken over by Greene King, a move that will create a company with 3000 pubs (Rankin, 2014).
There was briefly the threat of a bidding war for Spirit, but cider company Magners walked away from the deal in January (Armstrong, 2015).
Spirit has seen a steady decline in its revenues over the past several years, mirroring the general decline in the industry. Last year, revenues sunk a further 2.1% over the prior year, and some previous declines were worse. Even with declining revenues, Spirit has been able to maintain a gross profit, though this has been declining as well. Likewise, the operating income has continued to fall, with the company needing to continually cut operating costs in order to contain the decline in operating margin. Profits have been up and down. When they are up, they are slim, for example ?21 million in FY13. When the company loses money, it loses big. In FY2011, there were writedowns that resulted in a loss of ?867 million. Last year was more of an operating loss, of ?175 million with interest and taxes being major culprits.
Total cash flow from operating activities has also been in a state of steady decline, in line with the declines on the income statement. This is a company that has been getting smaller for some time, and it has also been bleeding cash for financing activities as well. Despite the shrinking company, its assets have fluctuated in recent years, suggesting that perhaps Spirit has not been in a state of steady sell-off of assets. Realistically, it probably will be once Greene King takes over. The company has been working to cut down its long-term debt, though this process has been somewhat gradual, and mostly in line with the reduction in its business. As such, its equity has been declining.
There are several ratios that can provide insight into the operations of these two companies. These ratios cover critical areas such as liquidity, solvency, profitability and investor performance (Loth, 2015). The key financial ratios for Wetherspoon are as follows:
The key financial ratios for Spirit Pubs are as follows (note: the company posted losses in 2014 and 2011).
*Punch Taverns managed estate, the predecessor to Spirit, was operated as a separate division within Punch from 2006-2011 and the numbers are obtained via the 2010 Annual Report for that company.
The ratio analysis tells us that Wetherspoon does indeed have a stable operation. Their current ratio may be slim, but they have held it. There is maybe some concern that it is declining, along with many other of the company's figures. It is reasonable to think that they have suffered at least a little bit from the overall decline in the industry and fierce competition among the industry survivors. The return on equity is perhaps the most telling area of concern, along with the return…