The humanisation of pets seems an unlikely investment trend to back. But the pet industry has an increasingly favourable outlook and some key companies are well positioned to grow.
I thought about the industry after watching our Schnoodle play with a Cavoodle and countless other dogs in neighbourhood park. The Cavoodle was immaculately groomed, had a winter vest and was on the end of fancy retractable leash.
I’m guessing the healthy-looking Cavoodle had at least $200 of accessories and grooming, pet insurance, regular visits to the vet and costly worming tablets. That’s not to mention the home accessories, pet toys, bed, and dog food.
What a waste, I thought, until realising that we do the same with our dog. As do many others who are spending more on their pets and treating them like a human.
It can be a big investment. The Cavoodle, bought from a breeder, probably cost upwards of $2,000. A friend joked that they need to extend their home loan to buy and maintain their pet. Another friend paid $15,000 in surgical bills after their beloved dog was injured in a nasty fall and broke several bones – they now have pet insurance.
Business forecaster, IBISWorld, estimates the pets and retail supply industry is worth $4.3 billion and had 2.8 per cent annual growth between 2011 and 2016.
IBISWorld notes that Australia has one of the highest rates of pet ownership: more than 60 per cent of households have one. It writes: “As pets become increasingly humanised, households are spending more money on them in the form of premium food, dietary supplements and vitamins, pet accessories and treats. Owners are spending more on each pet, increasing investment in premium products and services. Premiumisation in pet ownership is becoming more common as potential pet owners purchase animals from professional breeders.”
IBISWorld expects growth in the pet supply industry to slow to 1.9 per cent annually between 2016 and 2021 amid greater competition. It predicts more industry category-killer superstores or co-location between pet retailers and veterinary clinics is in large-format retailers – a positive trend for industry leader Greencross, which owns vet clinics and Pet Barn.
The $2.7-billion vet industry also has good growth prospects, says IBISWorld. Higher uptake of pet insurance, growing awareness of pet health issues and greater availability of surgical procedures is underpinning growth. “Due to higher incomes and insurance levels, people have been willing to spend more on vet procedures to prolong their pets’ lives,” wrote IBISWorld.
On supply, the vet industry remains highly fragmented: many one to three-person clinics that are ripe for consolidation and integration into large vet chains that derive greater economies of scale.
Greencross is a beneficiary from these trends. It has had a challenging few years on the market by its standards, falling from a $10.78 peak to $6.32 amid fears of rising competition and higher prices to buy clinics as new operators enter the industry. Investors who bought Greencross at $1 share in its 2007 float have still done exceptionally well.
Chart 1: GreencrossSource: Yahoo
Greencross reported a solid FY16 result in August. Revenue rose 14 per cent to $733.7 million and underlying earnings (EBITDA) rose 12 per cent to $97.5 million. The total dividend rose 9 per cent to 18.5 cents.
However, Greencross’ guidance for similar growth next year was below market expectation and a reason for its lingering share price weakness.
I still believe Greencross can leverage more gains from combining its pet and vet operations. Its strategy to roll out in-store clinics in retail outlets looks like a winner based on early performance, and there is scope to add more stores and clinics (numbers increased by 14 in FY16)
The big opportunity, possibly underestimated by the market, is the potential to increase customer engagement and spending. Customers who shop across more than one Greencross format grew 36 per cent in FY16 to 136,000, representing 21 per cent of sales revenue. The company’s cross-selling strategy is working.
Put simply, Greencross is increasing it share of the customer spending as more people choose it for retail supplies, veterinary services and pet grooming. I like businesses that are able to sell more and more to an existing customer base and at higher margins – and meet their needs – rather than always having to find new customers at lower margins.
Morningstar values Greencross at $8.50 a share, a significant premium to the current $6.32. Macquarie Equities Research has a $7.50 12-month share price target.
Greencross has plenty of work ahead to lift earnings growth and justify a re-rating and higher valuation. But a forecast price-earnings (PE) multiple of 15.6 times on FY17 earnings, based on consensus analyst estimates, is realistic given its growth prospects.
Greencross’ smaller rival, National Veterinary Care, is also worth following. It raised $30 million at $1 a share in an August 2015 initial public offering (IPO) and trades at $1.80. Like Greencross, National Vet Care is buying up smaller operators and consolidating a fragmented industry.
Chart 2: National Veterinary CareSource: Yahoo
National Vet Care’s after-tax net profit for FY16 exceeded prospectus forecasts by 13 per cent. It performed better than prospectus on most key financial metrics, which is always a good sign. The stock is on a trailing PE of about 17 times – arguably high for a micro-cap with a year of history as a listed company, but so far National Vet Care has earned its premium.
I’ll stick with Greencross for now. There’s a lot to like about its long-term strategy in the attractive pet industry and enough evidence that it can improve implementation in the next two years and drive another re-rating of its share price.
As a small-cap stock, Greencross suits experienced investors comfortable with higher risk.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without taking into account your objectives, financial situation or particular needs. Before acting on the information in this article you should consider the appropriateness of the information, with regard to your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at September 15, 2016.