Pet Valu Holding (TSE: PET): A 40% historical EPS compounder (20% forward base case) available at less than 17 times forward earnings
Current Price: ~$28 | 20-month Target Price: $46 (CAD), Dividends ~$1, TSR: 68% | TSE: PET
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Company & Industry Overview
Pet Valu Holdings was founded in
1976, and acquired by Roark Capital in 2009. Pet Valu Holdings is a franchise pet retail
omnichannel operation (unique model), where approximately 72% of all stores
are franchise-owned. Pet value is usually the co-leaser or sub-leaser for the
units that house these stores. Online sales are shared between stores. Pet Valu
most importantly acts as a wholesale arm to these stores, which in turn pay ~6%
of sales back to Pet Valu.
The Canadian pet industry is a recession-resilient above GDP
growth market. This means in a downward economic cycle Pet Valu kept
(volume and price each) positive (unlike other retail businesses). It yet still thrives from market
share gains in a Canadian pet market, where spending at 2023 price levels has
compounded at ~7.5% CAGR from 2015. The pet population has only
compounded at a ~0.5% indicating a long-term premiumization tailwind (Statista).
There are approximately 9 million households in Canada with pets, 28.1 mil pets
including fish in 21 vs 27.5 in 2016.
Investment Thesis Summary (Just read
this if you don’t have enough time)
Up until the 2023 recessionary(ish)
slowdown in Canada, Pet Valu has compounded same-store sales at double-digits (including Covid)
and at 5%+ during 2023. In this period the average square feet per store have
only compounded at 2.5% CAGR. There are two features to crack in this business:
Number 1, customer service focus is prime as pets are basically children that
never grow up (and you love spoiling and need help spoiling), and lastly, it’s
a difficult supply chain to crack for products people care about. Online
testimonials and 30% of
online customers choosing in-store delivery, including autoship, are indicative
of a great customer experience as people choose to come in-store (Delivery free
above 49 CAD)! Their supply chain clearly works as 90% of goods to
franchisees are delivered by Pet Valu wholesale arm, and they have a 1000+ franchise application
backlog for this very reason (every quarter). A franchise model works
because you have entrepreneurs creating exceptional service, and it carries an
asset-light model with the wholesale benefit (large $ for low-invested capital).
If you have time, in-depth below
Thesis 1: Pet consumption is niche,
pet valu’s model works, and we can continue expecting market share gains in a
~7-8% volume CAGR market
This has been a high single-digit
compounder and in the next 5 years will continue to be so as humans need pets
as emotional companions (and the cost justifies the utility one gets). Customer
testimonials such as those below will highlight why Pet Valu gains market share: -
|
Customer testimonials
include “yes Pet Valu and Ryans/Global is "expensive" but
they carry high quality food, not like the cheap stuff that Petsmart carries.”
And many comments such as “I don’t trust Amazon for pet foods as they
have sent expired stuff”. “Really in terms of foods it is about
avoiding the junk, you want to look for foods that don't have animal by
products ( ex chicken beaks and intestines)…. Pet Smart does carry a few brands that don't have
the by-products” |
Good quality items such as this
(amongst top rated consumed items) are cheaper in Pet valu (unavailable in Pet
smart). Chicken driven food bags (thoroughly not recommended for consumption),
which are more popular in Petsmart and Amazon (sub $50) are cheaper in these
places. Pet Valu has established a supply chain that works for customers
(replicating this with service isn’t easy). Given this a ~6% same store sales growth
system wide isn’t unreasonable (as base) nor untenable. Customer
loyalty data points in Fig 5 and 6 further support this thesis. This is also a
reason why Pet Valu franchisees purchase 90% of goods from Pet Valu.
This is totally optional and remains a reason (wholesale exclusive to
franchisees along with corporate stores) why interest in Pet Valu franchisees
remain so high (yes brand is important as well). Furthermore, majority of new
franchisees are purchased by existing franchisees (usually getting out of a
franchise agreement is difficult and is clearly not the case here).
These customer loyalty data points
are very compelling and indicate a consistent growth story despite 2023,
where the industry only grew 1% in constant price spending. The growth has a
long runaway + is sustainable. Unlike the rest of the industry, price/mix (avg
ticket per transaction) has only been about 4-6% from 21-23. During this time
market share gains haven’t been incremental despite Pet Valu growing at double-digit volume on a same-store basis. This clearly shows a difficult supply
chain, where fragmented players are taking prices at double-digit due to supply
chain difficulties on premium product demands. Lastly, online order pick-up
numbers range at 30% (49 CAD minimum free delivery), which shows customers
enjoy taking pets to the store because service is better driven in franchise
environments run by entrepreneurs + interaction with other pets.Runway of growth is not an issue for
new stores as I assume 40
stores a year in line with mgmt. 40-50 guidance for the next 5 years. They only cover 75% of Canada
within a 5km radius creating an opportunity for at least 250 stores (200 stores
over next 5 years assumption).
In conclusion, a good supply chain +
great customer service driven by a franchise model is very successful and
difficult to imitate overnight.
Thesis 2: Acquisition tailwinds and
new franchises create incremental growth opportunities to same-store sales
One franchise store on average (as
per guidance) does 2 million CAD on a 3750 square feet model (including online
sales share). Assuming a 40 – 42% (comps indicate this range for pet retail as
well such as Petco and Pets at home) GM (pre-franchiser expenses such as
royalty), this means roughly a COGS worth 1.18 million CAD. Purchasing 90% of
this from Pet Valu means 1.062 million. This implies a wholesale revenue to the franchise of 53% (assuming corporate stores and franchise stores do the same on
a per-store basis, not entirely accurate but around a ballpark is).
Pet valu acquired Chico in February
2022, and 66 stores which by year end grew to 82 stores, and by 2023 to 87
stores. Now because Chico was never on Pet Valu’s network they never consumed
Pet Value wholesale products. By 2026, mgmt has guided this number to be 70%
and in near terms 50%, I expect it by 28 to be 80%. Anyone who contacts Pet
Valu’s franchise network in Quebec, they only refer them to Chico (verified by
talking to a prospective applicant). This ensures that Chico is now part of Pet
Value (nothing less), and long-term normalization is inevitable. Fig 8 also
shows that Royalties and sublease revenues have fallen as a % of estimated
franchise sales. This is because Chico royalties are 2% vs 6% for pet valu.
With more than 1000 willing applicants, I don’t think a gradual increase for
Chico’s base is impractical either. I think the market has severely
underestimated Pet Valu’s supply chain strength that supports incremental growth
from these acquisition tailwinds as I think existing and new owners will gladly
accept new terms/ opportunities.
Thesis 3: Recent margin compression
is not due to industry problems but new DCs
There were two major headwinds for
Pet Value. 30% of goods are USD-denominated imports that have suffered from a
falling CAD and number two a new DC in GTA and Vancouver. Pet Valu has suffered
from undercapacity for its demand and had to rely beyond its legacy DCs in GTA (Greater Toronto
Area) + Vancouver. They had to tap into 3 3PL (3rd party
logistics) facilities in GTA, one in Calgary and one in Vancouver. Not only did
their legacies hold little automation (very old facilities), the 3PLs were more inefficient
than their legacies with almost all of it being handpicking. As guided in earnings call in mid-23 and
confirmed in Q1 24, they will fully exit (early termination of leases due to
locking in very low rates) the 2 legacies and the 5 3PLs. For guidance,
warehouse automation has grown high-single-digit to low-double digit
(emphasising the value added). The approximate headwind was 180 bps on GM
primarily because of paying rents for both the new GTA DC and Vancouver DC (not
ready yet because of work being done). The former is said to be fully
functional by Q2 of this year (means its running now), and the latter would be
by end of this year. As such I expect 90bps (excluding COGS Depreciation)
improvement this year and next year. For more context, Pet valu absorbs the 20 million CAD in
step up and occupancy costs (roughly 1.9% of 23 sales) without using either of
the new facilities. This also allows Pet Valu to be more aggressive on
discount pricing & pushing volume as they have been operating at 100%
capacity in 2023.
Thesis 4: Franchise + wholesale
business (Low asset business + cash cow)
A typical franchise store does 2
million CAD in revenue, with a rough estimate of COGS worth 1.18 million CAD.
1.062 million CAD is purchased from PET Valu wholesale business. 6% of
non-grooming sales goes as royalty (generally 1-2% is grooming, but for ease
purposes let's take 0%). This means on a 2 million franchise store Pet Valu
earns 59% of revenue, for a minority shared co-lease obligation (to explain why Fig 9 and Fig 10
are superior). ROEs are inflated from double-digit financial leverage;
however, with a strong asset turnover, and rising EBIT margins (despite a falling
GM due to operating leverage from a franchise retail model), ROEs are also a
32% normalized on 2 – 2.5x financial leverage basis. Net-Debt/ EBITDA has never
been over 2x during its course as a public company, so it’s smart use of
leverage even at a double-digit financial leverage ratio.
Valuation and risks
Extrapolating from my DCF, comps,
itself history, I think NTM P/E of 18.0x or trailing of 23.0x is an appropriate
exit multiple (historical since IPO average is 22 and 25 corresponding). I land
at a base case EPS of 1.87 CAD in 25 and 2.31 CAD in 26. Applying that I get a
price target of 46 CAD + ~ 1 CAD in dividends (+ no share buyback beyond FY 24
as FY 24 they have an authorised NCIB for purchasing 2.5% of common outstanding
shares).
- · Currency is a major risk
as for every penny change US-Canadian exchange, a 10 to 15 basis points
movement in GM is foreseen if prices can’t be passed
- · Corporate store
contribution has gone from 38 to 28%, which means wholesale contribution (a
lower margin business) has increased. While that should imply lower margins,
that hasn’t been the case because specialty goods have been margin accretive,
which may not be the case going forward (not scared because it will come back
in franchise and sublease revenue if that is the case)
- · A long-term recession in
Canada means I cannot foresee same store sales growth beyond 1 + 2% (Volume +
Price/mix), and an exit multiple of close to its lows 14x forward implying a
share price target of ~30
CAD (2026 2.06 CAD EPS) with 0.5 to 1 CAD cumulative giving a bare case scenario of breaking
even on the stock
- · Alternatively at double
digit growth same store sales growth rates seen in 21 – 22, we expect a 2.66
CAD EPS with 22 forward NTM P/E exit (Average not peak), gives a bull case ~60 CAD exit
(+ dividends) giving compelling risk asymmetry
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