Gross margin assumptions reflect i) rational competitive dynamics around promotional activity, ii) the Company’s strong and deliberate positioning in proprietary brands across good/better/best profiles, and iii) traction of its loyalty program with >70% sales penetration. In our view, the combination of market share gains, network growth, fixed cost scaling, franchise structure leverage, and efficiencies should more than offset headwinds.
Robust industry backdrop underpinned by 3 MM new pets adopted during the pandemic, 80% of which are under two years of age. Upside to long-term aspiration of 1,200+ stores, in our view. PET is currently filling the runway to 2023/24, with white space in both existing and new markets, and in the early innings of leveraging customer insights and incorporating location data in real estate decision process. Our long-term model remains predicated upon 1,200 stores with upside bias as PET takes share of wallet in existing/new markets and the Quebec opportunity comes into focus.
Capital light franchise model drives FCF growth and conversion, and shareholder returns. Our analysis suggests ample FCF and balance sheet capacity to fund growth, de-lever the balance sheet and, in time, accelerate return of capital to shareholders. Franchise store penetration forecast to rise from 68% in Q2 to 71% at the end of F23, which should drive accelerating FCF conversion and ROIC in the high 30% range, at the high end of the range in our universe of coverage.
Results support PET’s premium valuation, reiterating OP rating underpinned by sustainable growth, FCF generation, and high-return franchise model. PET trading at ~14.2x NTM EBITDA(Ex. 5), slightly below the post-IPO average. On a relative basis, trading multiple is well below DOL, largely in-line with ATZ.