Dog-proof your portfolio with CVS

Anyone who has visited their local vets will have noted a distinct lack of corporate glamour. Few other companies have hair and worming powder lying around their offices. However, since regulations were relaxed in 1999 to allow non-vets to own practices, investors have rushed to cash in on the then-cottage industry, and over half of the UK veterinary market is now controlled by six corporate giants.

Aim-traded CVS (CVSG) is one of them, with over 500 veterinary surgeries, three laboratories and seven crematoria in the UK, the Netherlands and the Republic of Ireland. CVS’s ability to hoover up small, locally-owned practices has long been a pull for investors, and the group’s growth has been rapid. In the half decade to June 2021, operating profit tripled, and is expected to climb by another 25 per cent this year.

Recent trading remains strong, in spite of tough comparators, while signs from other corners of the sector are cheering. Pets at Home’s (PETS) vet business, for example, reported like-for-like growth of 17 per cent in May, and puppy and kitten registrations remain well ahead of pre-pandemic levels. The group expects the significant increase in pet numbers to deliver incremental revenue as they age. 

It’s not all positive read-across, however. Over the past decade, the sector has become increasingly competitive, and CVS is sparring with companies such as Medivet and VetPartners, which are backed by private equity firms. These owners like to fund “roll-up plays”, which involve buying large numbers of small practices and merging them into large groups, which in turn helps cut costs. Dental surgeries have attracted similar interest in recent years, and it’s perhaps surprising that a similar trend hasn’t emerged in the largely unconsolidated legal services sector, which saw ownership rules relaxed in 2011.

Sold a pup

The transformation of the veterinary industry may have hit a roadblock, however. In February, the Competition and Markets Authority (CMA) raised concerns about an acquisition made by CVS. In what is believed to be the first case of its kind, the regulator warned that the combined businesses would account for a “significant portion” of veterinary services in Bristol, Nottingham, Portsmouth, Southampton and Warrington, and that pet owners could face “a worse quality of service, including more limited treatment options, or having to pay higher prices” as a result. The intervention could mean that CVS is forced to divest the entire business. 

The news has shaken investors, and CVS's shares are down by roughly a quarter since the start of the year. Future competition concerns, some fear, could seriously limit the group's expansion plans, as the CMA concluded that any acquisition that involves building a market share of more than 30 per cent within an easy drive time of a customer’s home would significantly lessen competition. This comes on top of concerns that private equity activity in the sector will drive up the price of future acquisitions. 

Analysts at Peel Hunt are optimistic, however. While they conceded that the watchdog’s intervention was not ideal for CVS, they argued that it would “materially diminish” competition for acquisitions because several the big bidders would be excluded based on what they already own. 

“As a result, the number of acquisitions that CVS can go for will diminish, but the proportion it can win is likely to materially increase and there will be less pressure on price,” Peel Hunt said, adding that overseas markets in Germany, France and Spain remain untapped. 

The development also means that CVS's shares are cheaper than usual, and trade on an 11.3 enterprise value-to-cash profit multiple for the current financial year, well below a five-year average of 17.1. This is also now below the wider sector, which analysts at Jefferies peg at a median multiple of 13.

Vet vacancies

In many ways, however, these arguments skirt around a more important development. Under previous management, CVS was defined by acquisitions, buying 62 practices in 2017, followed by another 52 in 2018. However, the results were often uninspiring and margins – together with return on equity – began to shrink. This resulted in a disastrous period for the shares, which plunged from a peak of 1,400p in November 2017 to little over 400p in February 2019.

The new management team, which came into power at the end of 2019, is more focused on organic growth, and has upped its spending on existing facilities, including on refurbishment, relocation, and investment in new equipment. It has also made an impressive dent in the company’s leverage: its net debt to adjusted Ebitda ratio was 0.76 as of 31 December 2021, compared with a multiple of 2.31 two years before. The group therefore enters a period of rising interest rates with its balance sheet on a surer footing.

A key part of organic expansion, of course, is the recruitment of more vets. This is not guaranteed to be straightforward. In its annual report, CVS said there continues to be a shortage of veterinary surgeons and, to a lesser extent, nurses in the UK, made worse by Brexit. This situation will only be made more difficult by the UK’s current hot job market, and there have been multiple reports of vet burn-out amid labour shortages. 

CVS’s ‘vacancy rate’ – which is calculated as the number of vet vacancies divided by the total number of roles – has crept over 10 per cent after falling steadily since 2018 (see graph). However, management said this reflects the fact that more roles are being advertised to meet client demand. Employee attrition, on the other hand, remains “broadly stable” and the group recruited around 200 new veterinary surgeons during the 2021 calendar year.

It has also teamed up with graduate vet schools to secure an inflow of new talent, increased staff holiday allowances, and changed remuneration to include a higher fixed pay element. This doesn’t come cheap, of course: employment costs as a percentage of sales increased to 50.4 per cent in the six months to December, compared with 48.9 per cent in 2021. However, CVS’s gross margin before clinical staff costs increased by 1.3 percentage points to 77.1 per cent, helping to relieve some of the pressure. 

At the moment, therefore, CVS looks well placed to hire and retain staff, and seems to have learnt from past mistakes. Earlier management teams drove vacancy rates up to 12.5 per cent after meddling with vets’ working practices. Meanwhile, our penchant for pets should keep demand high as we emerge from the pandemic and as enamoured owners discover the true cost of puppy love.