Pet Valu Holdings Ltd.
Pick of the litter: Reiterating compelling SMID cap idea ahead of Q1 results
Our view: Forecasting EBITDA $42.1MM (+17% Y/Y) and EPS $0.29 (both unchanged) when PET reports Q1 results May 10. Estimates underpinned by strong pet adoption rates with scaling and franchise model contributing to GM expansion. We remain constructive on Pet Valu as a compelling SMID cap, defensive consumer retail idea underpinned by sector-leading organic growth outlook as surge in pet ownership in COVID should underpin long- term demand for products and services. Reiterating OP rating, $42 target.
Key points:
Forecasts unchanged ahead of Q1. Estimates include about five weeks contribution from the acquisition of Chico closed February 25, and assume SSS +14.5% that implies three-year SSS CAGR 11.9%. In our view, the combination of strong pet adoption rates, market share gains, network growth, fixed cost scaling, franchise structure leverage, and efficiencies should more than offset the effect of rising wage and supply chain costs.
Long tail of pet care demand even as adoption rates normalize. With consumables representing about 70% of spend and with annual toys/play purchases, annual or bi-annual updates on bed, crates and related items, and average pet lifespan of 8-12 years, the industry is in the very early innings of a long tail of organic growth as it services the 3 MM new pets adopted during the pandemic, 80% of which are under two years of age. As well, the digital channel remains a significant opportunity for PET, with penetration only ~1% in 2021 and omnichannel capabilities accelerating.
Long-term aspiration of 1,200+ stores achievable, in our view. PET is filling the runway to 2023/24, with management confirming white space in existing and new markets, and bias to the upside in the Province of Quebec. Prior to the acquisition of Chico, management identified potential for approximately 200 stores in the province, but the acquisition is providing insight into potential markets that were previously excluded.
Organic growth story with strong industry dynamics, leading market position, and compelling hybrid business model. Based on our analysis, the Company’s hybrid corporate/franchised structure combines the best of both models. The robust network of owned and operated stores provides an effective platform to test new concepts and technologies at scale; the capital-light franchised structure provides recurring royalty and rent revenue augmented by wholesale merchandise sales that drive strong and sustainable free cash flow conversion and capital return metrics.
Reiterating OP rating underpinned by sustainable growth, FCF generation, high-return franchise model. PET trading at EV/EBITDA-growth 1.6x, roughly in line with peers (Ex. 4). Franchise store penetration forecast to rise from 64% in Q4 (67% including Chico) to 71% at end of F23, which should drive accelerating FCF conversion and ROIC in high 30% range, and high end of the range in our coverage.