At first sight, JD Wetherspoon (LSE:JDW) might look like a business in decline, especially set within the UK’s struggling pub scene. But I think a closer look at the FTSE 250 chain reveals a very attractive investment opportunity.
The stock’s been falling recently. But the underlying business has been strengthening its competitive position and I think it’s set up for long-term success.
Business model
JD Wetherspoon’s famous for its low prices. And while this puts it in a powerful position with customers, this isn’t the most attractive thing about the stock from an investment perspective.
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There’s a durable appeal to charging lower prices than the rest of the industry. But it doesn’t make for a good business unless it’s backed up by lower costs than its rivals.
Wetherspoon however, has a number of key advantages in this regard. Some are obvious, such as its ability to buy products at scale, but others are less apparent.
One of these is the company’s strategy of owning its pubs outright rather than leasing them. I think this is an important advantage that might be getting overlooked by the market.
A business in decline?
The number of pubs JD Wetherspoon operates has declined from 951 to 801 over the last decade. That looks like a cause for concern, but I think the result’s an improved competitive position.
As a result of those closures, the company now owns 71% of its estate outright, up from 47% a decade ago. This brings down a key cost for the firm – rental expenses.
Wetherspoon reduced its pub count by 27 last year, saving itself £37m in long-term lease liabilities in the process. Over time, that should mean two things.
One is lower prices for customers, reinforcing the company’s distinctive value proposition. The other is lower costs, which should translate to wider margins and better returns for shareholders.
Risks
What JD Wetherspoon wants to do least is put up its prices to customers. Every time it does this, there’s a risk people will decide they can’t afford to go to its pubs as often, or at all.
The company’s ability to avoid doing this though, isn’t entirely under its control. There are some costs it can’t do much about, including energy and staff.
If these start increasing further, the firm could find itself with margin pressures it isn’t able to relieve easily. But, of course, the rest of the industry will have to deal with the same challenges.
Furthermore, they’ll have to do it with Wetherspoon’s other cost advantages. As a result, even if higher costs pressure the company’s bottom line, they could improve its competitive position.
I’m still buying
Since the start of the year, shares in JD Wetherspoon have fallen by around 13%. But sales have been strong during the first half of the year, even as the firm continues to reduce its pub count.
It might take a while for its reduced lease liabilities to show up in earnings, but I think the long-term picture looks good. As a result, I’m looking to keep buying the stock for my portfolio.
