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Beware of Pets at Home

The one-time stock market darling is struggling in an increasingly competitive marketplace
March 30, 2017

We see a number of long-term challenges facing one-time stock market darling Pets at Home (PETS) and think it is time to sell the shares.

IC TIP: Sell at 182p
Tip style
Sell
Risk rating
High
Timescale
Short Term
Bull points
  • Gross margin growth
  • Online sales growth
Bear points
  • Like-for-like sales squeeze
  • Increased competition
  • Management change
  • Analyst downgrades

Faced with declining like-for-like growth rates, analysts have spent the past 12 months downgrading both forecast earnings and forecast earnings growth for the years ahead (see graph). Given the high margins the group currently commands, we think there is plenty of scope for this downgrade trend to continue, especially given the rising competitive pressures from online players.

Indeed, the company has already admitted it will need to lower its prices this year if it's going to reignite volume growth. We advise offloading the shares ahead of full-year results in May, which may well highlight a softening consumer outlook and rising cost pressures in addition to the existing troubles.

 

Pets' falling forecasts

 

Third-quarter trading saw Pets at Home's like-for-like sales growth dip to an anaemic 0.1 per cent, which included a 0.5 per cent like-for-like fall in merchandise sales (pet food and accessories), the source of 87 per cent of its revenues. This marks a continuation of an unwelcome trend, with group like-for-like growth falling from 4.2 per cent in the year to the end of March 2015 to 2.2 per cent in 2016. What's more, first-half like-for-likes this year were just 1.8 per cent prior to the disappointing third quarter 0.1 per cent. Another cause for concern is that growth in sales through Pets' VIP loyalty scheme have not kept up with growth in VIP customer numbers, suggesting that loyal customers are spending less per head. And while sales of veterinary services have been stronger, this part of the business currently only accounts for about 13 per cent of revenues.

 

 

Pets at Home has tried to keep its stores busy by moving away from the high street to more promising shops in retail parks. But, while footfall data suggests this has been a canny move, the advances being made by online competitors, as well as other retailers, provide cause for concern. Pets at Home is now competing with supermarkets and online specialists such as Zooplus and Fetch - Ocado's online dedicated pet shop. And, while Pets' online sales are good, the margins its competitors are prepared to accept on their sales suggest the changes afoot in this part of the market could do further damage to its retail stores.

Online pet shop Zooplus, in particular, is starting to become a serious worry in the UK. According to figures from broker Liberum, the German company grew its UK revenues by 40 per cent last year to £66, which builds on a five-year compound average growth rate of 39 per cent. While this is still relatively small scale compared with Pets' top line, we think Zooplus is now too large to ignore. Indeed, with about four-fifths of Zooplus' turnover coming from food, its implied sales in this category are already 14 per cent of the £390m food sales achieved by Pets last year. And significantly, Zooplus, along with other rivals, seems prepared to accept far lower profits on the sales it makes than Pets. Having cut gross margins from 38.9 per cent to 28.4 per cent over five years to win market share, Zooplus now makes only half the 57 per cent gross profit on sales reported by Pets last year.

We also think last year's unexpected change of chief executive at Pets unsettled investors. Nick Wood left the business quickly, citing the need to spend more time with family. He was succeeded by Ian Kellet, the chief financial officer.

PETS AT HOME (PETS)
ORD PRICE:182pMARKET VALUE:£910m
TOUCH:182-183p12-MONTHHIGH:275pLOW: 179p
FWD DIVIDEND YIELD:3.7%FWD PE RATIO:13
NET ASSET VALUE:171p*NET DEBT:19%

Year to 31 MarTurnover (£m)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
201466552.20.50.0
201572987.013.55.4
201679397.315.47.5
2017**83992.914.77.2
2018**87587.713.86.8
% change+4-6-6-6

Normal market size: 3,000

Matched bargain trading

Beta: 0.64

*Includes intangible assets of £989m, or 198p a share

**Liberum estimates, adjusted pre-tax profits and EPS