This paper analyzes the financial performance of JD Wetherspoon and Spirit Pubs (Punch Taverns) over five years (FY2010–FY2014), comparing their strategic positioning in a declining UK pub market. While the industry contracted by 0.3% annually with 10,000 closures in a decade, Wetherspoon achieved consistent revenue and profit growth through aggressive cost leadership, maintaining slender margins (2.9% net) but superior per-property efficiency. Horizontal and ratio analysis reveals Wetherspoon's operational stability and excellent management, contrasted sharply with Spirit's revenue decline, mounting losses, and vulnerability to acquisition. The paper concludes that Wetherspoon represents the superior investment, despite elevated valuation multiples, while Spirit's underperformance made it a takeover target acquired by Greene King in 2014.
JD Wetherspoon is one of the largest pubcos in Britain, with 880 properties and annual turnover of £1.409 billion (Yahoo! Finance, 2015). The company competes with a cost leadership strategy, something that should be reflected in 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, one of Wetherspoon's biggest rivals amongst corporate pubcos and fellow member of the FTSE 250.
The pub industry in Britain is both large and fragmented, with 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 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 approximately 7.8% share of the market by revenue. 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.
Despite the dire news 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 pursuing 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 it makes 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 evident in Wetherspoon's financial statements. As the company has slowly and 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 higher turnover than other pubs. It is entirely possible that this holds both for pubcos and independent pubs.
Spirit is one 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 1,229 pubs, which is roughly a footprint of 3.7% of pub properties. These results indicate that, on average, Spirit pubs 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 3,000 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 presented in the following table:
JD Wetherspoon Financial Ratios (FY2010–FY2014)
Current Ratio: 2014, 0.31 | 2013, 0.33 | 2012, 0.32 | 2011, 0.35 | 2010, 0.37
Quick Ratio: 2014, 0.22 | 2013, 0.24 | 2012, 0.22 | 2011, 0.25 | 2010, 0.26
Debt/Equity: 2014, 4.3 | 2013, 3.9 | 2012, 5.1 | 2011, 4.7 | 2010, 4.6
ROE: 2014, 18.1% | 2013, 21.3% | 2012, 26.4% | 2011, 27.5% | 2010, 31.4%
ROA: 2014, 3.4% | 2013, 4.5% | 2012, 4.3% | 2011, 4.7% | 2010, 5.6%
Gross Margin: 2014, 8.5% | 2013, 8.8% | 2012, 12.7% | 2011, 9.6% | 2010, 10%
Net Margin: 2014, 2.9% | 2013, 3.5% | 2012, 3.8% | 2011, 4.4% | 2010, 5.1%
Spirit Pubs Financial Ratios (FY2010–FY2014)
Note: Company was privately held in FY2010 and posted losses in 2014 and 2011.
Current Ratio: 2014, 1.4 | 2013, 1.4 | 2012, 1.33 | 2011, 1.5 | 2010, n/a
Quick Ratio: 2014, n/a | 2013, n/a | 2012, n/a | 2011, n/a | 2010, n/a
Debt/Equity: 2014, 10.9 | 2013, 10.5 | 2012, 15.5 | 2011, 14.6 | 2010, n/a
ROE: 2014, n/a | 2013, 7.1% | 2012, 24.5% | 2011, n/a | 2010, n/a
ROA: 2014, n/a | 2013, 0.6% | 2012, 1.4% | 2011, n/a | 2010, n/a
Gross Margin: 2014, 44.4% | 2013, 46.1% | 2012, 47.7% | 2011, 48.2% | 2010, n/a
Net Margin: 2014, n/a | 2013, 4.5% | 2012, 10.3% | 2011, n/a | 2010, n/a
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 perhaps 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 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 on assets. In both cases, Wetherspoon has posted a five-year decline, which is very much cause for concern.
Spirit Pubs recorded a loss in FY14 and in FY11. In FY10, it was privately held, so the data is somewhat incomplete. However, some conclusions can be drawn from a ratio analysis of this company. The first is that Spirit has much higher margins than does Wetherspoon. This implies higher costs, which might explain why it is struggling, though much of their estate is in London and the Southeast, where margins do tend to be higher. Still, even with high margins, Spirit has been unable to sustain profitability in the face of rapidly declining sales. It can be surmised that perhaps Spirit Pubs, regardless of their cost structure, are not offering consumers enough to justify higher prices.
The debt-to-equity ratio is also cause for alarm. While the company has good liquidity, its gearing is far too high, perhaps as the result of the multiple reorganizations it has faced over the past several years. While the gearing has declined, it is still very high, an issue that doubtless Greene King will need to address.
JD Wetherspoon's stability and growth in an industry that is struggling overall should play well with investors. Not surprisingly, then, the five-year chart shows that Wetherspoon's shares have risen from just over 500p five years ago to the current price of 780p. The five-year high was recorded in the spring of 2014. With a five-year gain of over 50%, JD Wetherspoon has outperformed the FTSE, which in the same time period has only risen 20%. The stock has been more volatile, but the company's ability to grow market share tells a positive story. Certainly, if one is seeking to invest in a pubco, Wetherspoon might make a solid choice. While most pubcos derive intrinsic value from their real estate holdings, Wetherspoon also offers a steady and growing income stream to attract investors.
By contrast, Spirit has performed less well. The company's stock has declined significantly from its value upon returning to the stock market, and in doing so it has underperformed the FTSE substantially. Spirit Pubs' high gearing, stock market underperformance, and consistently eroding sales made it a takeover target, and it ended up with two companies interested. The Greene King offer valued the company at £774 million, compared with a book value of £274 million. The value of Spirit's real estate holdings is unclear, but when the company was re-acquired by Punch in 2006, the average value of a pub was £1.4 million. Since that time, Spirit had to write down the value of its real estate significantly, but the current transaction values the pubs at around £630,000 apiece, a substantial decline. This could also imply that Greene King got good value on the real estate. Nevertheless, the company was struggling quite badly and the deal was received well by both Spirit management and by stockholders.
"Investment guidance for both companies with arbitrage opportunities"
Though the pub industry is facing a strong and prolonged downturn, JD Wetherspoon is a success story with its cost leadership strategy. While it earns slender margins, the company is growing its revenues and profits every year. It has been rewarded by investors for this success as well, with an escalating stock price that perhaps exceeds its actual financial potential. That said, its ability to consistently outperform its competitors makes it a compelling buy, especially relative to an underperforming company like Spirit Pubs.
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