Judging by founder Tim Martin’s public support for the leave campaign, J D Wetherspoon (LSE: JDW) shareholders should be hoping the pub chain will be well-suited to life after a possible Brexit. With the vast majority of its 954 pubs in the UK, Wetherspoon doesn’t have to worry about issues such as passporting rules for banks and selling beer remains a somewhat recession-proof business.
However, even if Wetherspoon is shielded from the worst possible financial effects of a Brexit, there are issues aplenty making me avoid the shares for the time being. Foremost among these is a dramatic fall in operating margins. Margins have compressed for six years running and fell from 7.4% to 6.3% over the past six months alone.
Falling profitability was largely related to an 8% increase in hourly wages and higher tax bills. Management has already said it expects the new living wage to affect a significant number of workers, so shareholders should expect further margin pressure in the future. Furthermore, net debt rose to 3.49 times EBITDA, its highest level in the past decade, as the company expanded its number of locations. With higher costs, like-for-like sales growth slowing and high debt, I’ll be avoiding Wetherspoon shares whichever way the referendum goes.
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Margin pressure
Wetherspoon’s larger rival Greene King (LSE: GNK) is likewise insulated from many direct effects of Brexit due to its domestic focus. But, as both place increasing emphasis on food and coffee sales, the UK’s largest pub chain is also vulnerable to consumer spending slowing if the worst predicted effects of Brexit come to fruition.
Greene King’s brewing operations are facing headwinds due to new government regulations reforming the ‘beer tie’ system in which pubs were required to buy drinks from their landlord. For Greene King, which leases out roughly 1,200 of its 3,000 pubs, this could be a major factor affecting margins in the future.
While the effects of these changes aren’t yet apparent, the latest half year saw operating margins drop from 20.1% to 19.6% year-on-year. Net debt also edged up to an uncomfortable 4.2 times annualised pro-forma EBITDA during the period thanks to the £774m acquisition of smaller rival Spirit Pub. Still, with steady cash flow and the prospect of margins stabilising as post-acquisition cuts are made, Greene King looks a more appealing option to me than Wetherspoon.
Dreading a slowdown
Whitbread (LSE: WTB), the parent of Costa Coffee and Premier Inn, brings in nearly all of its profits from the UK but that hasn’t stopped the board from joining the fray and declaring that Brexit would be bad for the business. While the vast majority of Whitbread’s hotel rooms and coffee shops are at home, the board believes that the uncertainty following Brexit would slow consumer spending.
A further slowdown in sales growth is the last thing Whitbread needs as like-for-like sales across the company rose 3% in the past year, less than half the level from a year prior. For a company that puts its retained earnings back into expansion, this is a worrying sign. Despite a 12% rise in total sales last year, Whitbread remains vulnerable to any Brexit-related slowdown in business travel or discretionary spending. As sales at existing locations slow and global economic growth grinds to a halt, Whitbread won’t be where I’m stashing my money right now.
