Pets at Home: the outlook on long-term revenues

Shares in Pets at Home (PETS) were heading in the right direction long before the ‘shelter in place’ diktats made us long for furry companionship. It’s well established that pet ownership spiked during the pandemic, but the group stands to benefit from the involvement of a key demographic.

Indeed, the Pet Food Manufacturers’ Association estimates that 3.2m households bought a pet during the period, with almost two-thirds of the new owners aged 16-34. Fertile ground for Pets at Home, which, unlike many other retailers, was allowed to keep its doors open during the lockdown.

Admittedly, the group’s share price has stuttered of late, after it was announced that chief executive Peter Pritchard would be leaving next summer. He has been with the business for 11 years, four of which in the top job, with his tenure characterised by rising market share and increased capacity. But a lengthy transition period should mean there is limited disruption at board level.

At any rate, the market reacted positively to half-year figures that detailed 21.5 per cent omnichannel – both in store and online sales – revenue growth (101 per cent on a two-year basis) and headline free cash flow growth of 51.3 per cent. Sales from the retail and food revenue segments increased by 22 and 21.4 per cent, respectively. And the underlying gross margin rose by 101 basis points to 48.7 per cent.

The group also highlighted a weekly average of 10,000 new client registrations for its First Opinion veterinary practices, together with a 45 per cent year-on-year increase in pet care plan subscriptions, generating £110m in recurring revenues annually. Progress on that last point is not accidental. The group employs an “always on” predictive model to target those customers most at risk of churn.

These increasingly sticky revenue streams also point to an underlying structural driver of the pet care market. Anyone who owns a cat and/or a dog (not a goldfish) is effectively on the hook financially for a decade or two, maybe longer, which equates to lots of repeat business.

Additionally, it’s worth remembering that people tend to make pet ownership a lifetime habit after their initial foray, so the rapid uptake in the Gen Z and Millennial demographics could prove highly significant over time.

Statistics also indicate that owners have become more aware of their pets’ healthcare needs during the pandemic. The group sums up all these consumer themes as “pet humanisation, premiumisation and renewal”.

There are other intrinsic advantages, as the group points out that most of its product is “sourced domestically on long lead times and is neither perishable nor seasonal”, doubly advantageous given the UK’s ongoing supply chain problems, although management did point out that the group was not immune on the logistical front, nor can it avoid widespread labour shortages.

We could see some slowdown in the rate of pet ownership as we exit the pandemic, but the addressable market has expanded over many years. Data from Statista shows that the UK pet care market has grown by an average of 8.9 per cent annually since 2005, hitting an aggregate value of £7.88bn last year. The group’s in-house estimates point to a more modest 4-5 per cent per year, a decent rate of increase, nonetheless.

To tap into this anticipated growth, the group increased capital investment by 89 per cent to £32.9m, with a focus on data analytics and business systems. This capital feeds into the omnichannel offering, which contributes to what the group describes as “a pathway to £2.3bn of customer revenue across our business over the medium term”.

A forward rating of 23 times forecast earnings isn’t extortionate, particularly given historical precedent, but we think it adequately reflects that full-year underlying pre-tax profit is expected at the top end of the current range of analyst expectations. Hold.

Last IC View: Sell, 384p, 24 Nov 2020