Pet Valu Holdings Ltd T.PET

RBC

[retiredcf]

February 27, 2024

Pet Valu Holdings Ltd.

Little ball of fur: Updating forecasts ahead of Q4 release, Reiterating constructive view

Our view: Although PET remains extremely well positioned with a mix that skews to consumables (~77% of revenues), fine-tuning assumptions to reflect accelerating pullback in consumer discretionary spending in Q4 and expectations for ongoing caution in H1/24. Revised Q4 EBITDA forecast $68 MM, $228 MM for 2023, slightly below guidance range $230-$233 MM reiterated at Q3 earnings release. Outlook remains solid, in our view, but diminished visibility and investor apathy for small cap, discretionary-oriented names could keep NT valuation rangebound. Reiterating Outperform rating and $35 price target.

Key points:

Reiterating our view that PET is well positioned for mix shift with good/better/best positioning and growing mix of proprietary brands at attractive relative value. Fine-tuning Q4/23 forecasts to reflect contraction in consumer spending on discretionary items. 2023E GM% essentially unchanged at 35.7% (-135 bps Y/Y) to reflect ongoing demand headwinds in more discretionary categories that began in May, FX pressure, shift to larger pack sizes, and a greater wholesale mix due to higher proportion of franchise stores, partly offset by sustained demand for premium nutrition, private label penetration, and lower inbound freight costs. Note that GM% excludes approximately 100 bps ($11 MM) of transient network transformation costs. Net of these costs, our estimate of IFRS GM% around 34.7% is broadly consistent with guidance “slightly below the Company's historical range of 35% to 36%”.

Supply chain investments should drive solid MT performance: Since IPO in 2021, PET has executed extremely well and delivered better- than- expected results despite what was an increasingly inefficient distribution network. We expect continued update from management on the timeline/ magnitude of supply chain investments to consolidate multiple operations in Calgary and Vancouver into scale facilities in 2024-2025, GTA successfully opened in 2023. Initial estimate for the program was $110 MM over the 2023-2025 period ($80 MM capex/$30 MM start-up costs). These 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 eventually initiate a share buyback. Our model defers share buybacks to 2025 favouring debt repayment over NCIB in the NT.

We remain constructive on the stock and reiterate our OP rating. Target multiple 11.0x broadly in line with 24E EV/EBITDA ~10.6x and reflects higher-for-longer interest rate backdrop and changing consumer demand patterns. Current valuation presents an attractive entry point, with PET trading at ~12.1x 2023E EBITDA, well below the post-IPO average (Ex. 6).