When I look at J D Wetherspoon (LSE:JDW) shares, what do I see? Low margins, low returns on capital, and a lot of debt? I’m not wrong, but I also see a growth stock set to double its share price.
The company’s earnings have been hit by the Covid-19 lockdowns and the stock is down 66% since the start of 2020. But it looks to me like it’s in much better shape than Mr Market thinks.
Covid-19
Unsurprisingly, J D Wetherspoon had a difficult time during the pandemic. The business reported free cash flow losses of 54p per share in 2020 and 68p in 2021.
On top of that, the company’s debt increased 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 came in at 17p per share.
I don’t think the debt is as much of a problem as some people seem to think, but we can come back to the debt in a bit. The reason I think the stock is going to double has to do with earnings.
Covid-19 was undoubtedly a big challenge for J D Wetherspoon. But the business did more than just survive – it made investments that I think give it long-term earnings power.
Investments
First and foremost, J D Wetherspoon has invested has made big investments in new pubs and buying freeholds. I expect this to provide a significant boost to both revenue and profits going forward.
Furthermore, the company lowered its prices during the pandemic while competitors didn’t. That gives it scope to increase them in future, while still having the lowest customer prices.
Those investments put the business in a stronger position than it was before the pandemic. But they also mean that last year’s free cash flow was around £76m due to one-off investments.
Adding those back in takes the free cash flow per share to around 70p. From there, I think that the stock has a clear path back to 92p – the amount it made when it traded at twice today’s price.
Debt
Ok, let’s get back to the debt. The company’s borrowings are arguably the biggest risk to the investment thesis here, but there are three reasons I think investors are overestimating this risk.
First, just over 80% of J D Wetherspoon’s debt is fixed at a 1.24% interest rate until 2031. At that rate, I don’t think it’ll get in the way of an earnings recovery for the next few years.
Second, the Chairman pointed out in the 2022 annual report that it emerged from the pandemic with a stronger balance sheet than before. This was due to an increase of 19% in the number of shares.
Third, the debt isn’t a short-term fix to get through a difficult situation. Most of the increase is the result of planned investments from before the pandemic.
A stock to buy?
Shares in J D Wetherspoons are already up 25% since the start of the year. And I think it has a lot further to go.
Exactly when the stock will reach £11 I don’t know. But I think there’s a lot of earning power here and I plan to buy the stock before the rest of the market realises.
The post Why this UK growth stock looks set to double appeared first on The Motley Fool UK.
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Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.