Pet Valu Holdings Ltd.
Don’t throw out the kitty with the litter: Necessary investments to strengthen competitive positioning
Our view: What appears to be getting lost in today’s share price reaction to PET's Q4 results/guidance is that since IPO, PET has executed extremely well and delivered better-than-expected results despite an increasingly inefficient distribution network.
Supply chain investments to consolidate multiple operations in the GTA, Calgary and Vancouver into scale facilities are estimated to total $110 MM over the 2023-2025 period ($80 MM capex/$30 MM start-up costs). The projects should lay the foundation to support long-term network growth by doubling capacity, and arguably drive incremental profitability over time through better efficiency, automation and elimination of third-party logistics. Importantly, our analysis also indicates the company generates ample free cash flow to fund investments, grow the dividend and initiate a share buyback, likely in 2023.
While today’s share price decline is likely (over)reaction to uncertainty as PET embarks on an accelerated capital project, we remind investors that PET does so from a position of strength, with SSS outpacing MSD industry growth, augmented by MSD NTI rollout.
Key points:
Raising 2023 EBITDA forecasts, EPS largely unchanged and at the high end of guidance $1.60-$1.66. Reflecting Q4 results/Q1 momentum and 2023 guidance into our model increases our 2023E EBITDA by 2.5% and our 2024E by 4%, with higher D&A and interest reflecting accelerating capex resulting in EPS forecasts essentially unchanged. Div. +67% to $0.10/Q.
Our 2023E adjusted EBITDA $237 MM (+10.2% Y/Y) is at the high end of guidance range $230-237 MM, as is our adjusted gross margin 35.8% that excludes approximately 80 bps ($13 MM) of transient network transformation costs, with H1<H2 as the company cycles CAD deflation and related impact on COGS. Company guidance indicates GM% “slightly below the low end of 35-36% historical range” including the network transformation costs.
We reiterate our thesis that incorporates stable GM% in the 35.5%-36.0% range over time, underpinned by rising PL penetration, DC efficiencies, store occupancy leverage and rising franchise fees. Moreover, with good/ better/best positioning and growing mix of proprietary brands at attractive relative value, PET is well positioned for potential mix shift, in our view.
Moderating target EBITDA multiple by half a point to 15x to reflect transient step-up in investments to support growth, $50 price target unchanged. Incorporating today's share price decline, PET trading at ~13.4x 2023E EBITDA, below the post-IPO average. On a relative basis, trading multiple is below DOL, above ATZ (Ex. 11 and 12).