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Investors’ Chronicle: AG Barr, JD Wetherspoon, Bellway

BUY: AG Barr (BAG)

Cost pressures hit margins, but revenue and profit progress demonstrate the strong brand equity on offer, writes Christopher Akers.

AG Barr shares were marked down by 3 per cent after the Irn-Bru purveyor warned of a “short-term impact on operating margins” from cost headwinds and the dilutive impact of last December’s acquisition of Boost Drinks.

Profitability pressures were evident in the year as supply chain cost inflation and higher investment levels took their toll on margins. Gross margin fell by 390 basis points to 40.3 per cent and the cash profit margin was down by 240 basis points to 17.7 per cent.

But this was still a solid year for the business, with attractive brand equity underpinning growth despite cost-of-living pressures. The chunky revenue uplift, with soft drink and cocktail solutions sales each climbing by 16 per cent to £267mn and £43mn respectively, was driven by both pricing action and volume growth. The Rubicon brand performance was a standout — sales were up by more than a fifth and volumes grew by 8 per cent.

And there could be more to come on the acquisition front after the purchase of Boost, which contributed £7mn of revenues and £1mn of gross profit over two months, and the rest of the equity in oat milk business MOMA in the year.

Chief executive Roger White said the company’s “focus is on organic growth, but with the net cash position on the balance sheet and market conditions the way they are, the board is alive to more opportunities”.

The results also touched on the deposit return scheme (DRS) in Scotland, which is set to go live in August despite industry concerns. AG Barr noted that the scheme, which if implemented in its current form will add a 20p deposit to alcohol and soft drinks in single-use containers, has “the potential to impact consumer purchasing behaviour”. New SNP leader Humza Yousaf has already clashed with the Scottish Greens over potential changes to the regulations.

The shares trade at 17 times forward earnings, according to the consensus FactSet position, below the five-year average of 20 times. This rating looks attractive for a company which, as house broker Shore Capital noted, has good prospects of a “margin rebuild and more dynamic growth over the medium to long term”. In the short term, the board remains confident that management expectations for revenue and profit growth in its 2024 financial year will be achieved despite cost challenges.

SELL: JD Wetherspoon (JDW)

Interest rate swap sales have allowed the pubs company to bring down its debt, writes Michael Fahy.

Things are looking brighter for JD Wetherspoon. Like-for-like sales for the six months to January 29 were up 13 per cent on the previous year and 5 per cent higher than pre-pandemic levels. Over the past seven weeks, like-for-like sales were up 15 per cent on last year, though the chain is still battling with what chair Tim Martin described as “ferocious” inflationary pressures.

Its adjusted pre-tax profit of £4.6mn was a significant improvement on the £26.1mn loss recorded last year but still less than a tenth of the £50.3mn earned in 2019. Statutory pre-tax profit of £57mn benefited from a one-off £65mn gain made from the unwinding of interest rate swaps.

Selling swaps created a cash inflow of £169mn, which allowed the company to make inroads into its debt pile. Borrowings excluding derivative and lease commitments fell by £177mn to £744mn. 

In the long run, its best hope of reducing this further lies with either selling more pubs or improving margins. Progress has been slow on the former. It put 32 pubs up for sale with CBRE and Savills six months ago, but only offloaded 10 during this period. Peel Hunt analysts said they think around 35 pubs are still on the market, and that one issue potentially holding back buyers is the fact that they may have to find different uses for the sites, given Wetherspoons typically owns another outlet nearby. A website marketing the pubs says 23 are under offer.

The company’s operating margin improved dramatically — to 4.1 per cent, from 0.2 per cent a year earlier — but there is still some way to go before it recovers to pre-pandemic levels of over 7 per cent. Achieving this rests on how much more it can eke out of its price-sensitive customers. Wage pressures remain acute and Peel Hunt forecasts that Wetherspoons’ energy bill will increase by around £25mn a month once its current contract ends in October.

Other pub chains have managed to pass on price rises, but the danger for Wetherspoons is that its customers sit at home instead. And although pub sales bring in cash, they’re hardly conducive to growth.

A 44 per cent jump in the company’s share price since the start of the year puts them on a valuation of 40 times FactSet consensus earnings for this year, or 23 times next year’s earnings. Given this is a business still in recovery mode, this seems too rich.

HOLD: Bellway (BWY)

The housing downturn is already hitting the housebuilder, but there is likely to be more pain to come, writes Mitchell Labiak.

Housebuilder Bellway posted a dip in pre-tax profits in its half-year results even as revenue ticked up 1.6 per cent thanks to the inflationary environment. The company said this was a “strong performance, notwithstanding the challenging operating and trading conditions in the period”.

Conditions are likely to get worse rather than better in the short to medium term. Many analysts are forecasting that house prices will have fallen by between 10 and 15 per cent by next year. So far, Nationwide has recorded a house price fall of just 1.1 per cent for the year to February, which gives some indication as to how much further prices have left to drop while interest rates remain heightened.

All of this, in addition to the end of Help to Buy this month, which accounted for 22 per cent of Bellway’s revenue last year, is why the company said its forward order book is down to £1.6bn from £2.21bn this time last year. It noted that forward sales have picked up when compared with the final quarter of last year, but house sales often pick up after Christmas, so investors should not see this as a sign of recovery just yet.

Bellway anticipates that it is “well placed to deliver volume output of around 11,000 homes in the current financial year” — the 12 months to July 31 2023 — compared with 11,198 homes for the previous period. This would only represent a slight decrease, but with houses being sold for less and construction costs higher, analysts’ predictions of a drop in revenue and earnings for this financial year now seem nailed on.

The question for investors is whether all of this bad news has already been priced into the valuation. It is currently trading at a sizeable discount to its book value and at 6.1 times its consensus forecast earnings for the current financial year. That could represent a good entry point for an investor banking on the housing market coming back to life by the end of next year, while recognising the difficulties facing housebuilders right now.

There are better-performing housebuilders out there which we see as stronger investment cases, such as Vistry — which has benefited from its Countryside merger — and Redrow — which sells homes to wealthier buyers who are less affected by higher interest rates and less dependent on Help to Buy.

While the recovery case for Bellway has merit, we maintain our rating considering the relative strength of its rivals.

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