Are these best-of-British stocks a buy amid Brexit uncertainty?
It's been a mixed morning for British stocks. Shares in pub chain J D Wetherspoon (LSE: JDW) have taken a battering. They're now down by more than 6% due to concerns about slowing growth and debt.
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Housebuilder Persimmon (LSE: PSN) has coped better. The York-based group is now "fully sold up" for 2016. Persimmon shares edged higher following this news, but remain significantly below pre-referendum levels.
In this article I'll take a closer look at both firms. Do these UK-focused stocks offer a buying opportunity for bold investors?
Is Brexit a problem for pubs?
The potential impact of Brexit on pub chains is still unknown. So far, the damage seems to be minimal. Wetherspoon's like-for-like sales rose by 3.5% during the 13 weeks to 23 October, with total sales rising by 2.3%.
Reassuringly, Wetherspoon expects to report an adjusted operating margin of about 7% this year. That's consistent with last year's figure of 6.9%. However, the firm did warn that rising wage and business costs could put pressure on profits.
Wetherspoon founder Tim Martin used today's statement to attack the "hectoring and bullying" approach of EU leaders to Brexit negotiations. But I suspect the real reason for his concern is the likelihood that the weaker pound will push up the prices of imported drinks.
One interesting highlight of today's statement was a comment on debt levels. Wetherspoon's net debt-to-EBITDA ratio, a key lending metric, is currently at a 15-year high of 3.47. A net debt/EBITDA ratio of two is usually seen as a sensible limit, so Wetherspoon's debt levels are very high.
The company says that while it recognises these risks, its net debt/EBITDA ratio is expected to stay at about 3.5 "for the foreseeable future." I'm not keen on this, especially as the group no longer appears to be expanding -- Wetherspoon closed a net total of 25 pubs last year, reducing its estate to 926 pubs.
Its earnings per share are expected to grow by 8% this year. In my view, both net debt and the forecast P/E of 17 are too high. I think the shares are likely to fall further over the coming months.
Should you buy housebuilders instead?
Persimmon's third-quarter trading statement was more encouraging. The group said that its private sales rate since 23 August has been 19% ahead of the same period last year. Persimmon is now sold up for this year, and has about £757m of reservations for future years.
Prices are said to be "firm" in regional markets, but Persimmon said that it recognises the uncertainty around Brexit and is taking a cautious approach to buying new land. Paying peak prices for land is a big risk for housebuilders. Doing so can crush profit margins, as the resulting houses must later be sold at prices based on lower land costs.
Cash generation remains strong, and Persimmon expects to end the year with net cash of more than £570m. Next year's forecast cash return of 110p per share looks safe to me.
Although the outlook for the housing market remains uncertain, Persimmon seems to be handling the situation well. With the shares trading on nine times forecast earnings, Persimmon might be worth a closer look if you're bullish on property.
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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
