Full year results at Pets at Home were broadly in line with prior expectations.
Revenues rose 7.8%, but pre-tax profits fell 16.6% to £79.6m as a result of the group's decision to lower prices, and a £5m provision against loans in the veterinary business.
The shares fell 3.2% on the news.
The full year dividend is maintained at 7.5p per share.
In theory, practice and theory are the same thing. In practice, they're not. Pets at Home is finding that out the hard way.
The group leads a resilient and growing market, and its stores are slicker and larger than independent rivals. The group should be able to hoover up business just by rolling out stores to new locations. Once open, additional services like grooming and vet practices can be tacked on, driving footfall up and increasing the likelihood of repeat custom.
Unfortunately it's not been that simple. Growth began stalling a year or so ago, and Pets has had to cut prices to remain competitive. A possible explanation is that customers are migrating to online retailers. In an online world, Pets is by no means a big fish and online competitors are much more dangerous than the independent stores the group has made light work of.
Despite the impact of lower prices on margins, we feel the group made a sensible choice given the options available. Pets needs to keep customers coming through the door if it's to effectively cross-sell those additional vet and grooming services.
The early part of the turnaround has gone reasonably well, with customers returning on the back of price changes. There's positive news elsewhere too, with sales of regular flea treatments jumping.
Pets will likely try and shift more sales onto similar subscription models. This kind of revenue is more valuable as it's likely to recur year-on-year, but recent changes to rules around customer data mean running targeted marketing campaigns to get customers signed up could prove more challenging.
The dividend looks set to remain well covered by free cash flow, and debt remains well within target levels. These factors should underpin the prospective yield of 5%, but for it to grow over the longer term, Pets will need to make improvements stick.
The shares trade on 11.6 times expected earnings. That this is below the average of around 14.6 since listing fits with our view that there's still plenty more work for new CEO Peter Pritchard to do.
Full year results
Revenues rose to £899m, driven by the net addition of 13 new stores, 25 new vet practices and 27 net new grooming salons, as well as 5.5% like-for-like growth.
The Merchandise division, which includes food and accessories, grew revenues 6.8% to £765.4m, driven by a 75.1% increase in online sales. Gross margin of 54.8% is down 2.85 percentage points on the back of price cuts, foreign exchange movements and a weaker sales mix.
Within Services, growth in vet and specialist referral services helped revenue rise 13.7% to £133.5m, although grooming sales momentum has slowed. Gross margin increased slightly to 34.1%, as a combination of one-off operational benefits and underlying improvements offset the impact of a £5m provision.
Lower profits impacted the group's free cash flow, which fell 13.6% to £55.8m. However, this inflow, and an absence of acquisitions, saw net debt fall £18.5m to £135.2m.
Looking ahead, Pets expects to open up to five superstores, 20-25 vet practices and 10-20 grooming salons in the coming year, but says the long-running challenge of finding suitable veterinary partners has been exasperated by the vote to leave the EU.
In the coming year, the second in Pets' three year transformation plan, it's targeting like-for-like revenue growth ahead of the market, and low single digit underlying profit growth. This is despite gross margin falling 0.75-1.25 percentage points as last year's price investment continues to weigh on performance.
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