Small Caps | Feb 23 2017
Growth options abound for veterinary chain and pet supplies business Greencross as it seeks to expand its one-stop shop concept.
-Financial pay-off from in-store clinics unlikely until FY19
-Yet expected to become a significant driver of value over time
-Post rally, stock considered fully valued
By Eva Brocklehurst
Veterinary chain and pet supplies business, Greencross ((GXL)) may not be posting the sort of growth that was booked years ago but its latest results highlight for brokers a relatively defensive business, with growth options in terms of private-label/exclusive brands for pet products and prescription diets. Recently released data reveals that, since 2013, domestic dog numbers have increased by 3% and cat numbers by 7%.
UBS notes a solid cash performance in the first half, although margins continue to slip across both the retail and veterinary divisions. The broker reduces earnings forecasts over FY18-21 by -10-13% as a result of the softer margin profile.
The broker believes the rolling out of in-store veterinary clinics adds to Petbarn's "one-stop shop" concept. Nevertheless, financial pay-off from these clinics is considered unlikely until FY19. UBS believes Petbarn, as the category-leading brand in a growing and fragmented industry, has plenty of growth options in the form of new stores, rising private-label penetration and in-store veterinary clinics.
The company has shown it can increase supply chain control while also extending its private-label into food under the Leaps & Bounds brand. The broker notes there has been a lack of organic growth in stand-alone veterinary clinics in recent history. This appears to be partially explained by a loss of customers following re-branding. Organic performance is expected to improve in the future as procurement benefits flow through to lower pricing and joint loyalty programs are more widely used.
Vet Clinics In Retail Stores
UBS believes that veterinary clinics in a retail store will work, although the co-location strategy is not yet proven. The Petbarn business has scale and the concept is supported by offshore experience in both the UK and US. The company has also recently taken control of its largest distribution centre.
While IT investment is likely to remain elevated and a new point-of-sale installation is likely, UBS does not believe these upgrades will stress gearing levels, estimating there is 25-28% head room in operating earnings (EBITDA) before additional equity would be required and this is an unlikely scenario. The broker maintains a Neutral rating based on forecast shareholder returns.
While operating cash flow highlighted a better supply chain and working capital management, the first half missed Deutsche Bank's expectations, largely in the veterinary business. The broker also remains underwhelmed by the retail growth, given the significant store expansion over the last three years, and suspects this is a sign of increasing competition and some saturation in parts of the market.
Domestic veterinary like-for-like sales growth of 5.3% was reported, with co-located clinics contributing around 2% to this figure. A net 26 locations were added to the network, which has increased to 401 sites. Three practices were acquired during the first half and Canaccord Genuity expects modest acquisition activity can to continue, while gearing is sound and the expansion is self-funded.
The broker incorporates further network growth into forecasts and allows for an additional five new stores in the second half, for a total of 21 new retail sites over FY17. Canaccord Genuity, not one of the eight stockbrokers monitored daily on the FNArena database, has a Buy rating and $8.40 target.
Macquarie observes both the retail and veterinarian businesses are performing well and the integrated strategy is delivering on the promise of cross referrals and revenue synergies. There are now 24 in-store clinics across a group and a further four under construction and management is keen to accelerate the roll out. The broker believes these new-to-market clinics are crucial to an increase in market share and should be a key driver of value for the group over the medium term.
Share Price Now At A Premium
The market reaction to the results suggests some concerns have been alleviated regarding underlying margins and the cash generation capability. Following the rally, the share price is trading at a substantial premium. Hence, Macquarie retains a Neutral rating.
Shaw and Partners is pleased with the initiatives management has undertaken, including growth in the loyalty membership and private-label dog food. Management intends to move into new varieties, such as premium dog and cat food, which are expected to contribute significantly, if overseas comparables are anything to go by. The broker estimates around 3.5% like-for-like growth in the core business, reflecting good retention of veterinary clinics and management practice initiatives.
The company has reported on data from Animal Medicines Australia, which showed strong companion animal trends, boding well for prospective periods, although strong market growth is yet to materialise. Shaw and Partners believes the company is essentially a retailer and remains reasonably priced next to other discretionary retailers, given the headwinds. The broker, not one of the eight monitored daily on the database, has Hold rating and $7.25 target.
The database has two Hold ratings and one Sell (Deutsche Bank). The consensus target is $7.10, suggesting 0.5% upside to the last share price.
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