Auditors Have Doubts About J D Wetherspoon (LON:JDW)

When J D Wetherspoon plc (LON:JDW) reported its results to July 2022 its auditors, Grant Thornton could not be sure that it would be able to continue as a going concern in the next year. This means that, based on the financial results to that date, the company arguably should raise capital, or otherwise strengthen the balance sheet, as soon as possible.

If the company does have to issue more shares, potential investors will be sure to consider how desperate it is for capital. So it is suddenly extremely important to consider whether the company is taking too much risk on its balance sheet. Debt is always a risk factor in these cases, as creditors could be in a position to wind up the company, in the worst case scenario.

Our analysis indicates that JDW is potentially undervalued!

What Is J D Wetherspoon's Net Debt?

As you can see below, J D Wetherspoon had UK£928.5m of debt, at July 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has UK£40.3m in cash leading to net debt of about UK£888.1m.

How Strong Is J D Wetherspoon's Balance Sheet?

We can see from the most recent balance sheet that J D Wetherspoon had liabilities of UK£338.8m falling due within a year, and liabilities of UK£1.39b due beyond that. On the other hand, it had cash of UK£40.3m and UK£23.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£1.66b.

This deficit casts a shadow over the UK£640.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, J D Wetherspoon would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.36 times and a disturbingly high net debt to EBITDA ratio of 9.6 hit our confidence in J D Wetherspoon like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for J D Wetherspoon is that it turned last year's EBIT loss into a gain of UK£21m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if J D Wetherspoon can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, J D Wetherspoon actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both J D Wetherspoon's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, it seems to us that J D Wetherspoon's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. While some investors may specialize in these sort of situations, it's simply too risky and complicated for us to want to invest in a company after an auditor has expressed doubts about its ability to continue as a going concern. Our preference is to invest in companies that always make sure the auditor has confidence that the company will continue as a going concern. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for J D Wetherspoon (1 is potentially serious) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.