Why this UK growth stock looks set to double

Stephen Wright thinks that the investments J D Wetherspoon has been making since 2020 make it a growth stock that is grossly undervalued at today’s prices.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

British flag, Big Ben, Houses of Parliament and British flag composition

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Key Points

  • J D Wetherspoon has invested £158m in new pubs and freehold reversions since 2020
  • Over 80% of the company's debt is fixed at low interest rate until 2031
  • The stock is down 66% since the start of the pandemic

When I look at J D Wetherspoon (LSE:JDW) shares, what do I see? Low margins, low returns on capital, and a lot of debt? I’m not wrong, but I also see a growth stock set to double its share price.

The company’s earnings have been hit by the Covid-19 lockdowns and the stock is down 66% since the start of 2020. But it looks to me like it’s in much better shape than Mr Market thinks.

Covid-19

Unsurprisingly, J D Wetherspoon had a difficult time during the pandemic. The business reported free cash flow losses of 54p per share in 2020 and 68p in 2021. 

On top of that, the company’s debt increased from £780m in 2019 to £991m in 2020, and that’s a major risk. Even with revenues back to their 2019 levels, free cash flow in 2022 came in at 17p per share.

I don’t think the debt is as much of a problem as some people seem to think, but we can come back to the debt in a bit. The reason I think the stock is going to double has to do with earnings.

Covid-19 was undoubtedly a big challenge for J D Wetherspoon. But the business did more than just survive – it made investments that I think give it long-term earnings power.

Investments

First and foremost, J D Wetherspoon has invested has made big investments in new pubs and buying freeholds. I expect this to provide a significant boost to both revenue and profits going forward. 

Furthermore, the company lowered its prices during the pandemic while competitors didn’t. That gives it scope to increase them in future, while still having the lowest customer prices. 

Those investments put the business in a stronger position than it was before the pandemic. But they also mean that last year’s free cash flow was around £76m due to one-off investments.

Adding those back in takes the free cash flow per share to around 70p. From there, I think that the stock has a clear path back to 92p – the amount it made when it traded at twice today’s price.

Debt

Ok, let’s get back to the debt. The company’s borrowings are arguably the biggest risk to the investment thesis here, but there are three reasons I think investors are overestimating this risk.

First, just over 80% of J D Wetherspoon’s debt is fixed at a 1.24% interest rate until 2031. At that rate, I don’t think it’ll get in the way of an earnings recovery for the next few years.

Second, the Chairman pointed out in the 2022 annual report that it emerged from the pandemic with a stronger balance sheet than before. This was due to an increase of 19% in the number of shares.

Third, the debt isn’t a short-term fix to get through a difficult situation. Most of the increase is the result of planned investments from before the pandemic.

A stock to buy?

Shares in J D Wetherspoons are already up 25% since the start of the year. And I think it has a lot further to go.

Exactly when the stock will reach £11 I don’t know. But I think there’s a lot of earning power here and I plan to buy the stock before the rest of the market realises.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Growth Shares

I bought 319 Scottish Mortgage shares for my SIPP in January. Here’s how they’ve done

Scottish Mortgage shares were out of favour in January so Edward Sheldon bought more of them for his pension. Was…

Read more »

Investing Articles

Is Tesco’s share price still a bargain after rising 26% over a year?

Recent results show Tesco is still growing its leading market share, and despite its share price gains this year, it…

Read more »

Investing Articles

Is this FTSE 250 gem the next big thing in defence sector shares?

This FTSE 250 defence firm was founded by the MoD, has seen its order book and profits swell, and is…

Read more »

Investing Articles

Here’s what the National Grid share price fall could mean for passive income investors

It's long been seen as one of the FTSE 100's best stocks for durable dividends. What does the recent National…

Read more »

Female florist with Down's syndrome working in small business
Investing Articles

£6,000 in savings? Here’s how I’d try to turn that into a £500 monthly passive income

With careful planning and patience, it’s not hard to earn a passive income with UK shares. Here’s one way to…

Read more »

Investing Articles

Here’s how I’d aim for a second income of £1,000 a month, with just £10 a day

How much do we need to build a decent second income? With enough time, we could do it with a…

Read more »

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.
Investing Articles

Down 12% in a month, is this the FTSE 250’s most overlooked gem?

Our author thinks Kainos is one of the most overlooked FTSE 250 gems. Here's why he thinks the future could…

Read more »

Shot of a senior man drinking coffee and looking thoughtfully out of a window
Investing Articles

Just released: our 3 best dividend-focused stocks to consider buying before July [PREMIUM PICKS]

Our goal here is to highlight some of our past recommendations that we think are of particular interest today, due…

Read more »