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Pets at Home - Restructuring and price cuts dent profits

Nicholas Hyett | 27 November 2018 | A A A
Pets at Home - Restructuring and price cuts dent profits

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Pets At Home Group PLC Ordinary GBP0.01

Sell: 304.60 | Buy: 304.80 | Change 5.40 (1.80%)
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Total revenue rose 6.7% in the first half to £499.3m, with like-for-like (LFL) revenue up 5.3%. However, underlying operating profit fell 9.3% to £39.8m as restructuring costs rose in the vets business and the group cut prices.

The dividend remains unchanged year-on-year, at 2.5 p per share, and the shares fell 1.3% in early trading.

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Our view

Pets at Home serves a resilient and growing market, and its stores are slicker and larger than independent rivals.

In the past that's helped it 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 all's not been so simple more recently. Cheaper online alternatives have forced Pets to cut prices to remain competitive. 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 lower sales prices trashing 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. But the problems now seem to have shifted to the veterinary business.

That's partly due to factors outside Pets' control. A decline in the number of EU vets in the UK is putting pressure on salaries and also making it more difficult to find new partners. But a shakeup of the business is still going to be expensive, and will see some practices close while others are brought under Pets' direct control.

With Pets targeting 50% of revenue from Pet Care, the restructure needs to deliver.

Pets will likely try and shift more sales onto subscription models - such as its flea treatment. This kind of revenue is more likely to recur year-on-year and an ever growing bank of customer data should facilitate targeted marketing campaigns.

For now the dividend remains covered by free cash flow, and debt is well within target levels. These factors underpin the prospective yield of 6.6%. However, it's difficult to see meaningful growth in the near term, and it's not beyond the realms of possibility new CEO Peter Pritchard feels that cash is more urgently needed elsewhere.

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Half Year Results

Pets' Retail stores saw revenues rise 6% to £443.7m in the first half, with LFL growth of 4.7%. That reflects significant efforts the group has made to cut prices, with prices within 5% of online competitors and 2% cheaper if customers opt for regular delivery. Online sales rose 45.2% to £35.3m.

However, price cuts mean gross margin in the division, the difference between the cost of goods and sale price, fell 1.3 percentage points to 51%. Divisional underlying operating profits fell 5.2% to £29.4m.

The Vets Group saw total revenue rise 12.3% to £55.6m, with LFL growth of 11.9% as the group's mature practices grew ahead of the market. Higher costs meant a significant fall in margins. Underlying operating profits fell 16.2% as a result to £13.7m, even before a £29m one-off cost is factored in.

Active VIP club members have increased by 100,000 since the half year to 4m, and 70% of revenue is now accompanied by a VIP card swipe.

Underlying free cash flow rose 17.7% to £27.3m, with net debt broadly unchanged from the full year..

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.