This has been a banner year so far for pub operator J D Wetherspoon (LSE: JDW). Its shares have soared 50% since the beginning of 2023. Despite that, J D Wetherspoon shares remain 15% below where they were a year ago – and around 60% down from where they began 2020, before the pandemic and government restrictions ravaged the pub trade.
In fact, despite their rise this year, I think they continue to look cheap.
I have bought more in recent months. If I had spare cash to invest today, I would happily buy even more, because I think the shares are still a bargain. Here’s why.
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Valuing J D Wetherspoon shares
To figure out what Spoons shares are worth, I think one first needs a view on the long-term outlook for the pub trade. The number of pubs is falling significantly and this may continue for some time.
Declining market size is a red flag. In this case, though, I think it may actually help Spoons. The chain is a price fighter with a proven business model. I think it stands to benefit from higher-priced rivals closing their saloon doors, as patrons move their custom to Spoons.
After all, the company’s valuation also depends on how large its own revenues are, whatever the market size. These have now passed the pre-pandemic level. I think that is a sign of how well run the business is.
The crucial element, in my opinion, is how much of those revenues Spoons can turn into profits. That can be challenging for an operator that competes on price, even before adding in the current risks to profits posed by rampant inflation.
Attractive valuation
Back in 2019, the company’s net profit margin after tax was 4%.
In its first-half results published last week, the figure was less than 0.1% (before allowing for certain one-off items). That is a razor thin margin. But with revenues growing and the business gaining momentum, I think Spoons should be able to increase its margins, hopefully significantly.
If full-year revenue growth matches the first-half level of 5% compared to pre-pandemic 2019 figures, and profit margins get back to where they were then, J D Wetherspoon shares currently trade on a prospective price-to-earnings ratio of 11.
I think it may take several years for profit margins to recover, but still see that valuation as highly attractive.
Risks and rewards
Of course, that presumes that things go well. The company has invested substantially in renovating its estate over the past couple of years. Growing revenues suggest that that is paying off. The hard balancing act now is to set prices at a level that can make good profit margins without scaring away custom.
With its proven business model, strong value proposition, large customer base and strong first-half results, I believe the company can make that happen. For a business of its quality, J D Wetherspoon shares continue to look cheap to me even after their strong performance so far in 2023.
