While Stifel analyst Martin Landry continues to believe Pet Valu Holdings Ltd. offers “a unique combination of growth and defensive characteristics, supporting the case for a premium valuation,” he thinks it will take investors time to accept its weaker-than-anticipated third-quarter guidance “before revisiting the story.”
Shares of the Markham, Ont.-based retailer plummeted 10 per cent on Tuesday after it reported lower-than-expected same-store-sales growth offset by better-than-anticipated adjusted earnings per share. However, investors reacted with concern to management’s plan for the remainder of the year.
“While demand for consumables remains strong (up double-digit year-over-year), there is softness in accessories and toys, which is putting pressure on same-store-sales growth,” said Mr. Landry. “As a result, management intends to increase promotional activity in H2/23 but this could result in margin pressure. Management expects Q3/23 EBITDA margins to be flat to down sequentially, which suggests an erosion of more than 250 basis points year-over-year. As a result, Q3/23 EPS could be down in the double digits’ percentage range year-over-year, which comes as a surprise given previous consensus estimates suggested a return to year-over-year EPS growth in Q3/23.”
While Pet Valu’s adjusted full-year guidance suggests a “strong” fourth quarter later this year, Mr. Landry said his view is less optimistic.
“Pet Valu’s Q3/23 guidance and unchanged 2023 outlook suggests a sharp increase in Q4/23 EBITDA margins to 25-per-cent-plus,” he said. “While this appears aggressive at first glance, the company expects to benefit from several factors including (1) lower distribution costs as they transition into their new GTA DC, reducing the need for third party logistic providers, (2) easing year-over-year FX headwinds and (3) lower SG&A expenses driven by cost control measures to better align SG&A expenses with sales trends.
“Our forecasts differ from management’s expectations as we see a risk of continued demand weakness in discretionary categories, which could impact sales of lucrative seasonal discretionary items in Q4/23. We also think that promotional activity may continue until year-end especially given Chewy’s entrance in the GTA in the coming months. Hence, in our view, there are risks that PET does not meet its 2023 guidance and as a result, our forecasts are lower than guidance with Q4/23 EBITDA margin of 23.5 per cent vs. guidance which suggests margins of 25-per-cent-plus.”
Mr. Landry is now projecting full-year earnings per share of $1.54, down from $1.62 and below the company’s guidance of ($1.60 to $1.66). He also dropped his 2024 projection to $1.73 from $1.85, citing “higher lease expenses reflecting the transition into the new distribution centres in the GTA and Vancouver.”
That led him to reduce his target for Pet Valu shares to $38 from $42 with a “buy” recommendation. The average on the Street is $40.56.
“Pet Valu is a growth story with a significant growth runway. We believe that the company can double its store count over time to 1,200-plus, an increase of 60 per cent from current levels,” he said. “According to our analysis, PET has the potential to grow its EPS sustainably at a CAGR [compound annual growth rate] of mid-to-high teens. Pet Valu’s balance sheet is healthy with leverage expected to remain below 2 times in 2023, providing the company with good flexibility to allocate capital.”
“Pet Valu has several positive attributes, which include: (1) more than 2.5 million members in its loyalty program, generating 80 per cent of all system sales in Q2/23, (2) high-performing private label brands, generating near 30 per cent of sales and margins 1,200 basis points higher than similarly priced national brands, (3) a rapid payback of three years on new corporate stores, (4) flexible store formats which enable increased penetration in rural areas, a significant differentiation vs. PetSmart.”
Elsewhere, others making target adjustments include:
* National Bank’s Vishal Shreedhar to $36 from $41 with an “outperform” rating.
“We reduced our estimates to the lower end of 2023 guidance,” said Mr. Shreedhar. “Also, we have taken a more conservative stance on 2024+ estimates reflecting lower sales growth and limited net benefit from the reduction of third-party logistics/efficiency initiatives. As a result, 2023 EPS goes to $1.60 from $1.62 and 2024 EPS goes to $1.75 from $1.84.”
* RBC’s Irene Nattel to $43 from $50 with an “outperform” rating.
* CIBC’s Mark Petrie to $36 from $44 with an “outperformer” rating.
* Barclays’ Adrienne Yih to $35 from $41 with an “overweight” rating.