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Pets at Home - full year improvement but outlook uncertain

Sophie Lund-Yates, Equity Analyst | 21 May 2020 | A A A
Pets at Home - full year improvement but outlook uncertain

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Pets At Home Group PLC Ordinary GBP0.01

Sell: 230.00 | Buy: 230.60 | Change -12.80 (-5.31%)
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Full year revenue rose 10.2% to £1.1bn, reflecting growth across Retail and the Vet Group. Improved operating margins meant underlying operating profit was up 10.9% to £103.3m.

However, the exceptional demand seen in the final quarter because of coronavirus has begun to unwind, and sales are now below normal levels for the current year-to-date. Paired with extra costs associated with Covid-19 and the sale of lower margin products, pre-tax profit for the first half will be "materially below" last year.

A final dividend of 5.0p has been declared, taking the total dividend for FY20 to 7.5p per share, flat compared to the prior year.

The shares fell 3.7% following the announcement.

View the latest Pets at home share price and how to deal

Our view

Pets at Home's position as an "essential" service means it can keep its doors open during current disruption.

But there are problems with being a chosen one. Keeping staff and customers safe and ramping up supply to meet an early surge in demand comes with costs. Unfortunately, the spike in demand seen in mid-March has simply poached revenue from further down the line too, and sales are now about 20% lower than this time last year. All that means profits and cashflow are being dragged down.

But we think Pets is well placed to capture demand once things get back to normal.

Most eye-catching is the continued rise in like-for-like retail sales, despite the continued rise of online competitors. Added to that is a sterling effort on cost control, which has seen reduced rents, combined with lower staff costs. Put all that together and there's a stronger foundation to lay profit growth in the future - although there are no guarantees.

Pets has worked hard to become a destination, rather than just a shop. Vet clinics and grooming rooms provide extra revenue streams, but also encourage cross-selling in the core retail business.

And we think there could be a chance for the group to reclaim its share of higher margin sales over time. Lockdowns mean a lot of pet-owners are going to come out appreciating their furry companions more than ever before. That could lead to a spike in demand for higher-margin accessories to pamper our pets with, as well as items to aid wellbeing like more expensive foods or supplements.

Of course, a severe recession could lead to customers sliding backwards on the value ladder, which would have the opposite effect.

Coronavirus has also accelerated the shift to online shopping. Pets has invested heavily and ramped up its digital capacity, which is a good move in our view. But in order for this to be really profitable the new infrastructure will need to be leveraged with a sustained increase in demand to match. We're excited by the group's enviable hoard of customer data, with 5.6m "VIP" members, whose data can be harnessed to provide better outcomes and drive sales. It's early days, but it could be an exciting growth opportunity.

The conservative net debt position is comforting in these uncertain times, and for now the dividend is well covered by free cash flow. But remember dividends are never guaranteed and the uncertainty could see Pets decide to keep that cash in the business in the near-term.

Overall we think Pets at Home is in a good position. But it's navigating uncertain territory along with the rest of the sector. There are some unique and exciting opportunities for growth, but investors should keep in mind there will be ups and downs from here.

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Full Year Results

Retail revenue rose 9.7% to £937.6m, with like-for-like (LFL) revenues rising 9.4%. Higher transaction volumes helped in store LFL sales increase 7.7%, and online revenue grew 27.8% to £93.8m. Underlying operating profit was £81.7m compared to £67.2m last year. Operating margins rose despite lower gross margins, as operating cost control - including lower staff costs - offset gross margin dilution caused by higher sales of less profitable food products.

All Grooming rooms have been closed since the start of lockdown. Prior to lockdown, grooming and pet sale revenues averaged £3.3m per four-weekly period

The Veterinary business saw revenue grow 13.9% to £121.2m, with LFLs up 5.6%. Fee income from the clinics operating as a joint venture increased by 2.1% to £53.8m, with LFLs also up 2.1%. This growth was down compared to last year, reflecting Pets' efforts to restructure the group, including buying out some clinics, in the year.

Higher profits helped underlying free cash flow reach £89.6m, compared to £63.6m last year. The Group's net debt position at the end of the year was £85.9m, which represents a leverage ratio of 0.6x underlying cash profits (EBITDA).

The uncertainty means Pets has taken steps to preserve near-term cash flow, including: moving to monthly payment of store rents, deferring capital and marketing spend, and agreeing a six-month loan repayment holiday with Vet Group banking partners for all Joint Venture Partners who are not currently debt free.

Pets at Home has access to £162m in undrawn credit and cash on hand, with an extra £100m credit facility now secured.

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