Pet Valu Holdings Ltd T.PET

TD

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Pet Valu Holdings Ltd.

(PET-T) C$27.28

Correction Creates Buying Opportunity While Awaiting Catalysts Event

Market growth and promo activity normalized several quarters earlier than anticipated, but long-term growth and valuation look very attractive, in our view. We have trimmed our 2023E/2024E/2025E EPS by 1%/4%/4% — we see PET hitting the bottom end of its 2023 guidance range. Applying a 20x-21x P/E valuation (down from 23x-24x to reflect slower growth and increased investor concerns around competition) reduces our target price to $41.00 (from $45.00).

Impact: SLIGHTLY NEGATIVE

Traffic growth is slowing as customers buy larger value-pack sizes amidst high inflation, and therefore need to enter the store less often — a trend that is unlikely to change until inflation slows and the economy strengthens. PET is adjusting its business model to hit its targets. This should reduce SG&A enough to support the higher promo activity by Q4/23 and allow PET to hit the bottom end of guidance.

EBITDA/EPS beat and management reiterated guidance, but the SSSG miss (return to long-term historical industry-growth rates) plus promotional activity returning to pre-COVID-19 levels quicker than anticipated pushed the shares down 10% yesterday. At 16.0x our NTM EPS, PET is trading marginally above the grocers, despite having a much-more-favourable long-term growth algorithm (higher industry growth, greater whitespace, asset-light model).

Catalysts on the horizon should push the shares higher. 1) when Chewy's goes live in Canada, we expect it to behave rationally, pricing similar to the market and alleviating investor concerns around increased competition — we question why Chewy would enter a market 1/10th the size of its home market with a high-cost distribution model and then choose to upset the industry's attractive market dynamics by pushing GM% lower and further limit its earnings potential. 2) PET's Q3/23 results should show stable-to-slightly-higher sequential SSSG, giving investors greater confidence in 2023 guidance.

TD Investment Conclusion

Concerns around short-term earnings pressure (GM% normalization, labour investments, higher depreciation, interest rates), as well as competition (Chewy's pending GTA entry) significantly compressed PET's valuation, in our view presenting an opportunity for investors to pick up a high-growth retailer at a big discount (16x vs, ~23x average, with the lowest-valued high-growth retailer and franchised operator among our comps at >20x) before long-term double-digit adjusted EPS growth resumes in Q4/23.