November 8, 2022
Pet Valu Holdings Ltd.
The Cat’s Meow: Reaffirming constructive outlook target to $46
Our view: Strong and higher than forecast Q3 results (again) and guidance revised upward (again) reinforce our view of PET as a compelling, growth oriented, staple-leaning, defensive SMID-cap idea in Canadian specialty retail. In our view, valuation bias is to the upside reflecting the earnings growth trajectory, sector-leading ROIC, and demonstrated resilience during prior periods of consumer spending slowdown. Reiterating Outperform rating, target to $46 (+$1).
Key points:
Tweaking forecasts to reflect Q3 results, momentum Q4-to-date and higher F22 guidance. Revised guidance implies moderating cadence in Q4 with our revenue growth estimate +13% and flat EBITDA sequentially, reflecting primarily: i) return of pre-pandemic promotional calendar, notably around Black Friday, ii) $1.8 MM non-recurring duty recovery in Q3 associated with COVID relief measures. For 2022, we forecast adjusted EBITDA +17% to $212.8 MM (guidance revised +3-4% to $212-$214 MM) and EPS +50% to $1.58 (guidance revised +4.5-6% to $1.56-$1.58). 2022E SSS +16.3% at the high-end of guidance range +15.5-16.5% (+13-15% at Q2, +9-12% at Q1 and vs initial guidance +6-9%) drives revenue to $938 MM (guidance $938-$947 MM). SSS outlook underpinned by combination of higher transaction count as pet owners return to pre-pandemic shopping behaviour along with higher basket. While inflation is driving up prices, PET is deliberately holding back on a portion of cost pass-through, notably in proprietary brands, which should widen the price gap vs national brands.
Management will provide 2023 guidance in conjunction with Q4 in March, at which time the effect of probable recession on consumer demand should come into focus. Nonetheless, it should be noted that humanization of pets underpins industry resilience, growing LSD during prior downturn with PET growing close to double the industry rate. With good/better/best positioning and a growing mix of proprietary brands at attractive relative value, PET is well positioned for potential mix shift, in our view.
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 (Ex. 9 and 10). Forecasting Franchise store penetration rising from 68% in Q3 to 72% at the end of F24, 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. Incorporating today's share price increase, PET trading at ~13.6x 2023E EBITDA (Ex. 12 and 13), a tick below the post-IPO average. On a relative basis, trading multiple is below both DOL and ATZ (Ex. 13).