Pets At Home Group PLC (PETS) Ordinary shares GBP0.01
HL comment (24 November 2020)
Half year revenue rose 5.1% to £574.4m, with like-for-like revenues rising 5.3%. That reflects strong trading in the retail business, especially in the second quarter. However, an increase in costs, lower margin online sales, and less profitable product mix, meant underlying operating profit was £49.6m, compared to £51.7m last year.
Full year underlying pre-tax profit is expected to be in line with last year at £93.5m - so long as there are no further restrictions or significant disruptions to trading.
The group announced an interim dividend of 2.5p, in line with 2019.
The shares fell 9.4% following the announcement.
Coronavirus is disrupting spending patterns. Increased demand for online shopping and lower margin "essential" pet items, like cat litter, are squashing margins.
But we think Pets at Home is in a pretty good position longer-term.
Most eye-catching is the growth 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 rents reduced along with lower staff costs. Put all that together and there's a stronger foundation for future profit growth.
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.
Lockdown doesn't just mean more pets. We suspect existing pet owners will emerge with a greater appreciation of their furry companions than ever before, although it's too soon to tell if this theory will ring true. That could lead to a spike in demand for higher-margin accessories, as well products that aid wellbeing like more expensive foods or supplements.
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. Achieving that will require near perfect execution of this expanded digital service, or there's the risk customers will switch their allegiance to rivals.
The group's enviable hoard of customer data, with 6m "VIP" members, should help, providing better outcomes and drive sales. If done right, this will boost the number of customers who buy both a product and a service from the group - a leap which massively increases the average annual spend of these customers and should also make them stickier. Pets at Home has only just started to crack this nut, so there's significant potential here.
We continue to think there's potential at Pets at Home. We're genuinely impressed by the legwork being put into marketing and online infrastructure, and lockdown pet ownership provides a structural growth opportunity. But it would be remiss not to shine a light on the valuation. The shares trade on a significant premium, meaning the group has to come good on its plans for near-exponential growth, or the market could reassess its opinion of Pets.
Pets at Home key facts
- 12m forward Price/Earnings ratio: 27.4
- Average 12m forward Price/Earnings ratio since listing (2014): 14.8
- Prospective yield: 1.9%
Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.
Half year results
Retail like-for-like (LFL) revenue rose 5.8%, as did overall revenue - to £507.8m. That includes a 65.8% increase in online sales, which now make up 15.2% of retail sales. Grooming revenue fell 36.4%, because of lockdown restrictions. Increased retail sales reflect a boost in pet-ownerships during lockdown, and significant growth in consumable categories like cat litter.
However, these items are less profitable, which together with the lower margins of online sales meant gross margin dipped to 48.5% from 49.9%. Operating margins fell from 7.7% to 7.9%, resulting in underlying operating profit of £38.9m, compared to £38.1m last year.
Veterinary revenues were broadly flat at £66.6m, with LFL growth of 1.2%. That largely reflects the limited procedures allowed during lockdown, and growth was much stronger in the second quarter. LFL fee income from joint-venture clinics fell 3.0%. Increased digital investment meant underlying operating profit was £16.7m, 5.1% lower than 2019.
The group saw a 15% rise in the number of "VIP" customers to 6.0m - with members shopping across more than one channel rising 20%. There are now 970,000 subscription customers too (up 22%), which are expected to produce £80m of recurring annual revenue.
Pets at Home has incurred £8m in one off Covid costs since the start of the pandemic, and related ongoing operational costs are running at about £0.15m a week. Capital investment over the half rose from £16.8m to £17.4m, including investment in the distribution network and new store formats. The amount spent on data analytics and systems more than doubled.
The conclusion of the joint-venture vets restructuring means underlying free cash flow more than doubled to £60.5m. Underlying net debt stands at £50.9m, which is equivalent to around 0.4 times cash profit. Pets at Home has access to cash and undrawn credit of £297.1m.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.
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