Stifel Stifel analyst Martin Landry thinks Pet Valu Holdings Ltd. possesses “significant” valuation upside as investors “get more comfortable” with its growing franchise business, which he called “a valuable asset.”
In a research report released late Tuesday, he gave the Markham, Ont.-based company a “buy” recommendation.
“Pet Valu currently has approximately 475 franchised stores, representing 67 per cent of the company’s network,” he said. With an average franchisee tenure of 9-years and a 98-per-cent renewal rate (from 2015 to 2020) Pet Valu’s franchise network is healthy. The company receives more than 800 inquires per year of which only 1 per cent are awarded a franchise, suggesting the network has a high appeal and quality franchisees. Management intends to convert more corporate stores to franchises over time.”
“Historically, investors have valued franchised businesses at higher multiples than corporate networks. Franchised businesses have asset light models with higher return on invested capital and are perceived as more attractive by investors. Franchised businesses carry higher profit margins and in most instances can be expanded faster than corporate networks leading to scale benefits. Franchisees typically have a higher community engagement and can be established in smaller markets due to their lower operating costs. We assembled a select group of franchised businesses. The average valuation multiple of our peer group is 19 times 2022 EBITDA, a valuation multiple we believe is fair for PET’s franchised business.”
Mr. Landry estimates the franchised business should be valued at $28 per share, or approximately $2.2-billion, and he also thinks its implied corporate store network valuation “appears too low.”
“Pet Valu’s business has solid organic growth prospects with SSS [same-store sales] growth guidance of 6-9 per cent, operates in a recession resistant industry which has not contracted once in the last 30 years in Canada and has potential to gain market share with a growing network expected to grow at 5 per cent in 2022,” he said. “Hence, we believe that Pet Valu’s corporate network should garner a much higher valuation multiple to reflect its appealing characteristics. Assuming a 12 times EBITDA multiple would suggest a valuation of $8 per share for PET’s corporate network.”
The analyst set a target of $44 per share. The average on the Street is currently $41.
”We see significant valuation upside for PET, for the following reasons: (1) PET has a healthy and growing franchised network which should garner a higher valuation, (2) Pet Valu has pricing power to pass on vendor inflationary pressures, (3) Consumer demand is somewhat inelastic as highlighted in our recent consumer survey,” said Mr. Landry. “Hence, we believe investors should revisit an investment in Pet Valu. We recently added Pet Valu among Stifel GMP’s top pick list.”