Fat Prophets take profits

Whilst we have enjoyed our dalliance with cheap pints and value driven lunches, all good things must come to an end. Having embarked on another terrific rally, the share price of pub operator JD Wetherspoon (LSE, JDW) currently stands 63% higher than it did upon our initial recommendation just 7 months ago. The company’s earnings strength in a recession is unquestionable however with the UK economy on the turn and the prevailing wave of positive sentiment, shares may be reaching a peak.

With the FTSE 100 sitting around 7% higher than it did in January, JD’s 63% share price ascent has been all the more remarkable. Its recession proof product has provided a welcome tonic for many an ailing portfolio in 2009, however in our view although the business model remains sound various factors point to limited upside potential for the share price.

The rationale behind the recommendation was JD’s ‘recession proof’ product. Pub companies may not jump out as an obvious defensive play, despite the old adage ‘people drink more in a recession’. However we were confident that pubs were to remain an integral part of British culture and drinkers rather than ‘giving up’ would differentiate on price and value.



And so it proved. JD’s pursuit of providing value for its customers continues to be unrelenting and it comes as no surprise that its 99p pints and £2.99 lunches have seen footfall increase.

Indeed, we recently reported that during the financial year-to-date (50 weeks to 12th July 2009), like-for-like sales increased by 1.2 percent and overall company sales increased by 5.2 percent. With new pubs a considerable contributor, not only did these figures this underscore the benefits of JD’s aggressive expansion but they also emphasised the group’s high retention of customers. Having been lured in on the back of a bargain customers remain regulars long after these offers are withdrawn.

Although JD will no doubt continue to pull in the punters, the imminent return of risk appetite to the market will in our view see investors focus on stocks which have been oversold which have potential for significant and rapid top line growth. JD remains at the forefront of the UK pub industry however given the return to form of China in this year’s second quarter its business plan lacks a developing world growth angle which is far more appealing at this current juncture.

Investors though will not simply banish memories of 2008 from their minds and hurl themselves into risk. Defensives will continue to play an integral role however lacking a dividend and having already been subject to a significant share price jump JDW shares will not be the obvious choice. Indeed like many others JD has had to prioritise debt reduction and scrapped its dividend earlier this year. Whilst this may have been a prudent move and has improved the group’s financial base, it reduces the appeal of the shares.



Our view that management’s pursuit of market share would see long term earnings well protected remains in place. After all, the company is taking advantage of the depressed commercial property market and will have boosted its portfolio by 39 pubs by the year end.

However, how much of this is already factored into today’s share price remains to be seen and today’s forward price earning multiple of over 15 times although not stretched is higher than upon our initial recommendation…. and without the backup of a 3.5% dividend.

As value based investors we are too aware that bearish sentiment can lead to opportunity whilst overly bullish sentiment can lead to pitfalls. At present, of the 17 brokers covering the stock, 9 rate JD as a buy, 6 are neutral and only 2 are recommending a sell; such a positive distribution of opinions is often the precursor to static and lacklustre performance.

Going against the opinions of investment banks has never concerned us and at the time of our initial recommendation banking heavyweight Deutsche Bank rated JD shares as a sell. Although not by design, our opinions differ from the main on a regular basis however today we sing from the same hymn sheet as Credit Suisse who earlier cut its rating to neutral from outperform, advising investors to lock in profits after the stock's 22% relative out performance since mid June.

Meanwhile, the actions of those closest to the company have also prompted us into action. Last month Chief Executive John Hutson almost halved his stake in the pub group, selling 50,000 shares at around 433.1p. Although the sale may not bear any reflection on his outlook for the company, it does not bolster investor confidence.

All factors considered JD shares require significant impetus if they are to continue their run of 2009 and we believe this will not be forthcoming.

Earlier this year Gordon Brown refused to punish the responsible majority by choosing against enforcing minimum prices for units of alcohol, however the issue will not abate. Drink-related illnesses cost the NHS £3bn a year, while the total expense to the taxpayer of alcohol misuse is thought to be £25bn a year. As such, the entire pub industry is weary of possible legislation and with JD’s business model very much value orientated it would be amongst the most affected if change is ushered in.

Whilst we are keen to make the most of our selections, a core principle behind our investment strategy is not to give into greed and as such we advised Members to sell half their JD holdings in April at 445p yielding a 57 percent in less than 3 months. Today’s decision to sell the remainder of our holding translates to a 63% gain in over 7 months on the remaining portion. JD represents a satisfactory investment decision.

As evident on the daily chart, resistance has emerged at 486p, capping the stock in both April and August. In our opinion, a broader consolidation range appears to be forming, between this resistance level and support in the 348p to 330p region. With the stock currently towards the upper boundary of this range, we believe now is an opportune time to lock in the profits we have made on this investment.

As such, we recommend Members sell half their JD Wetherspoon shares at current levels.