Conversations at Bearbull’s local – and unofficial – dog walkers’ association often turn to the vexing matter of the cost of running the four-legged creatures. Less than a child, but a darn sight more than running a gas-guzzling SUV is the consensus; with the colossal costs of pet insurance relative to car insurance, you would think that’s almost a given.
On one issue the opinion of the dog walkers is almost unanimous. Once a veterinary practice falls into the maws of private equity, two things happen – first, prices rise horrendously; second, the consistency of care drops in inverse proportion. Granted, some of this is about people’s propensity to moan. Yet it’s almost tangible – enter a vets’ practice owned by private equity and there’s something in the air that tells you ‘Get ready to be fleeced’, which has nothing to do with the length of your cockapoo’s fur.
Even the UK’s competition watchdog, the Competition and Markets Authority, has sniffed it out. In September, it launched a review of the veterinary sector, saying “it will explore how well the market, worth over £2bn in the UK, is working for pet owners”. The regulator is right to be concerned. After all, it notes that 10 years ago 89 per cent of vets’ practices were independently owned, usually meaning they were owner-managed by vets. Today, that proportion has halved to 45 per cent. Meanwhile, as the chart shows, price inflation for vets’ services has far outstripped consumer price inflation (CPI). Since 2015, vets prices have risen 66 per cent faster than the CPI average and are currently rising at twice the CPI rate – 12.1 per cent in the year to October compared with 4.6 per cent.
Yet it will be difficult to disentangle from other factors the effect on prices of higher concentrations of corporate ownership. As in human healthcare, labour costs in the animal version have had to respond to skills’ shortages, higher levels of pet ownership, plus – the curse of all affluent societies – rising levels of customer entitlement.
So how concerned should I be for the Bearbull Income Portfolio’s holding in Pets at Home (PETS), a £1.5bn provider of supplies and services for domestic animals? Maybe not that much because vets’ practices are important to the group – it runs about 450 of them, generating about 10 per cent of sales – but they are not as central to it as they are to, say, CVS Group (CVSG). So, while CVS’s share price has dropped 30 per cent since the regulator growled, Pets at Home’s has only fallen 22 per cent.
Not that underwhelming results for the first half of 2023-24 have helped. Although revenue was 7 per cent up, operating profit was 17 per cent lower at £55mn. Yet its bosses are confident underlying pre-tax profit for the full year will be about the same as 2022-23’s £136mn, enough to produce about 23p of earnings and to justify a maintained 12.8p dividend, which would mean a 4.1 per cent yield. And City analysts expect earnings growth of about 15 per cent in 2024-25, followed by almost as much the year after. Admittedly, that’s still far off, but that sort of pace of growth could well keep private equity sniffing around. Pets has already had a four-year spell in private equity’s hands, and last summer was rumoured to be attracting more interest from the high-leverage merchants. All the more reason to stick with shares in a business nicely positioned to benefit from various retail segments of the competitive but highly price-elastic pet care industry.
Are Victrex's best years behind it?
Meanwhile, in a company’s accounts, sometimes it is the little figures that speak the loudest. Take the speciality chemicals group Victrex (VCT), which does clever things with polymers and whose shares are also in the Bearbull portfolio. Its inventory levels (stock in various forms of completion) rose by over a half in the year to end September and closed at £135mn, by far the highest amount in the past 10 years. The knock-on effect is that resources tied up in working capital finished the year £49mn higher than they started. This, also, was an amount completely out of sync with the past 10 years when, despite its lively growth, Victrex was more likely to be sucking out working capital than putting it in.
Thus the question arises, do these figures speak of a group whose best years are behind it? Obviously, its bosses snort at such a suggestion. In announcing the results for 2022-23, chief executive Jakob Sigurdsson says the group can grow its revenue by around 6 per cent a year in the mid-term and maybe by 10 per cent if progress is good in its so-called mega programmes. These focus on high-growth opportunities, including coating cabling for electric vehicles, making plastic pipes for deep-water oil fields or plastic knee joints in orthopaedics. Against the backdrop of a 10 per cent drop in sales for 2022-23, such growth would, indeed, be welcome.
So it’s a bit of a letdown when management quickly adds that, so far this year, it sees no improvement in demand and, consequently, expects growth to be second-half weighted. Yet it is as well to remember that, even in as dull a year as the one just gone, Victrex generated a 26 per cent profit margin and that the average margin for the past 10 years is more like 36 per cent. Figures for return on assets (five-year average about 16 per cent) or on equity (19 per cent) are similarly impressive.
Roughly speaking, this is why its shares are in the Bearbull portfolio. Margins such as those, combined with a debt-light balance sheet, should ensure its dividend is safe – and currently generating a 4.2 per cent yield – while I wait for whatever catalyst it is that gets the share price moving. The predictable bet is that Victrex could be another target for private equity, who might be tempted to move soon as a heavy capital-spending cycle draws to a close. However, I’d be perfectly happy if, in effect, passive investors act first and take Victrex’s share price out of private equity’s reach. We’ll see.
Record faces challenges
One business that’s unlikely to be a private-equity target, but which also faces challenges is currency manager Record (REC). While its shares remain the best performer in the Bearbull portfolio, they have had a poor time lately, falling 28 per cent since June to their current 73p. That response looks a bit odd since there has been lots of volatility in foreign exchange markets this year as markets have struggled to cope with the stubbornly-restrictive ways central banks have combatted inflation.
Usually, volatility is good for Record as its clients – mainly institutional investors – seek the protection the company’s hedging tools can bring. But that wasn’t reflected in results for the first half of 2023-24, which showed a 3 per cent drop in revenue and a 17 per cent drop in pre-tax profit to £6.3mn. Chiefly, management blames delays in launching new products and the effect of high inflation on the company’s costs; these are dominated by personnel costs, which rose 13 per cent on the previous first half. Still, chief executive Leslie Hill – set to retire in March after 32 years with Record – says new product launches are forthcoming and that earnings per share for 2023-24 will meet City expectations (about 5.2p). Given that almost all of that will be distributed as a dividend (at least 4.6p, say) the resultant 6.3 per cent yield should steady the share price, whose fall looks to have flattened out anyway. One to hold, especially if sterling’s recent revival against the dollar continues.
