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when I look JD Wetherspoon (LSE:JDW) actions, what do I see? Low margins, low returns on equity and a lot of debt? I’m not mistaken, but I also see a growth stock poised to double its share price.
The company’s profits have been hit by the Covid-19 lockdowns and shares are down 66% since the start of 2020. But it sounds to me like it’s in much better shape than Mr. Market thinks.
COVID-19
Unsurprisingly, JD Wetherspoon went through a difficult time during the pandemic. The company reported free cash flow losses of 54 pence per share in 2020 and 68 pence in 2021.
On top of that, the company’s debt rose from £780m in 2019 to £991m in 2020, and that’s a major risk. Even with revenues back to their 2019 levels, free cash flow in 2022 was 17 pence per share.
I don’t think debt is as big of a problem as some people seem to think, but we can get back to debt in a moment. The reason I think the stock will double has to do with earnings.
Without a doubt, Covid-19 was a great challenge for JD Wetherspoon. But the business did more than just survive: it made investments that I believe give it long-term earning power.
Investments
Firstly, JD Wetherspoon has invested heavily in new pubs and buying freeholds. I expect this to provide a significant boost to both revenue and earnings going forward.
Also, the company lowered its prices during the pandemic while competitors did not. That gives you room to increase them in the future, while still having the lowest prices for customers.
Those investments put the business in a stronger position than before the pandemic. But they also mean that free cash flow last year was around £76m due to one-time investments.
Adding them back brings free cash flow per share to around 70 pence. From there, I think the stock has a clear path back to 92 pence, the amount it was earning when trading at twice the current price.
Debt
Ok, back to debt. Arguably the company’s loans are the biggest risk to the investment thesis here, but there are three reasons why I think investors are overestimating this risk.
First, just over 80% of JD Wetherspoon’s debt is pegged at an interest rate of 1.24% through 2031. At that rate, I don’t think it will stand in the way of earnings recovery for years to come.
Second, the president noted in the 2022 annual report that he emerged from the pandemic with a stronger balance sheet than before. This was due to a 19% increase in the number of shares.
Third, debt is not a short-term solution to get you through a difficult situation. Most of the increase is the result of planned investments from before the pandemic.
A stock to buy?
JD Wetherspoons shares are already up 25% since the start of the year. And I think he has a long way to go.
I don’t know exactly when they will hit £11. But I think there is a lot of buying power here and I plan to buy the stock before the rest of the market takes notice.
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