Shares in pub chain J D Wetherspoon (LSE: JDW) were down by 10% at the time of writing on Wednesday.
The firm’s share price fell after Brexit-backing boss Tim Martin warned that rising wage costs wouldn’t yet be passed on to customers through higher prices. As a result, profits are expected to be slightly lower than those achieved last year.
Less than two months ago, Martin said that like-for-like sales growth of 4% in 2018/19 would be enough “to match last year’s record profits.” The firm’s first-quarter trading has exceeded this threshold, with like-for-like sales up by 5.5%.
I assume that the company’s decision to increase wages this week was made before the publication of its full-year results on 14 September. So today’s revised guidance suggests to me that market conditions are proving to be tougher than expected. I can see two possible reasons for this.
One is that operating costs are rising faster than expected. The other is that tougher competition from rivals means that Martin doesn’t think he can push through price increases without losing sales.
In either case, the end result may be that Wetherspoon’s profit margins come under pressure this year.
Good company, but is the price right?
As a Spoons customer, my experience is that most of the firm’s pubs are well run with friendly staff, cheap drinks and a decent budget menu. As my colleague Graham Chester explains, the firm’s distinctive offering makes it a potential “category killer”.
From a financial point of view, free cash flow has been consistently strong and margins have been stable in recent years. A return on capital employed of 10.5% is higher than many rivals. Although net debt is higher than I’d like to see, it’s similar to rivals and should be manageable.
However, my estimates suggest that the stock trades on a forecast P/E of about 15.5 after today’s news, with a forward yield of 1%. I’m not sure this is cheap enough to reflect the risk of falling profits. I plan to stay on the sidelines for now.
Cruising to a profit
One company whose profits are unlikely to be affected by rising UK wages is the world’s largest cruise ship operator, Carnival (LSE: CCL). As cruise regulars will know, most ship operators recruit low-paid hospitality staff from emerging markets, keeping costs low.
The Carnival business — which owns brands including Cunard, P&O, Princess Cruises, and Holland America — has seen considerable growth over the last five years. Annual profits have risen from $1.1bn in 2013, to $2.6bn in 2017.
Rising demand for cruise holidays shows no sign of slowing. Although I can see a risk that the number of new cruise ships being launched each year will eventually leave the market saturated, I don’t think we’ve reached that point yet.
Analysts expect Carnival’s earnings to rise by 10%, to $4.24 per share this year. That puts the stock on a forecast P/E of 12.9 with a dividend yield of 3.4%. In my view this could be a good entry level for an investment in this market-leading business.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Carnival. 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.