Small Caps | Feb 18 2016
-Co-location strategy lauded
-Weak H1 in WA but turning
-DRP suspension welcomed
By Eva Brocklehurst
Greencross ((GXL)) continues to dominate the pet care and veterinary market, as management consolidates its network of stores and clinics and executes its online strategy.
Earnings were up 17% in the first half, with like-for-like sales growth of 5.1%. Western Australian-based City Farmers was softer, which was the main drag, brokers observe, on an otherwise solid result. City Farmers represents 17% of retail sales. Veterinary services earnings grew 22% while New Zealand growth was 7.0% .
Deutsche Bank considers the company is well placed to leverage its position in an attractive market, despite increased competition for veterinary practice locations. Cash conversion improved, which highlights better supply chain management in the broker's view, although this needs to deliver more proof of its sustainability in the second half. The broker considers the stock, trading on a forward price/earnings ratio of 18x, is fairly valued and retains a Hold rating and $6.60 target.
Net debt improved, easing pressure on the balance sheet. Despite industry feedback pointing to increased competition and price pressure, CLSA highlights management's commentary that there has been no pressure on Petbarn's gross margin to date. Hence, broker's confidence in the outlook has improved, along with the more solid balance sheet. Minimal upside is envisaged to the current share price and CLSA retains an Underperform rating and $7.00 target.
The top line was a little weaker than expected but UBS acknowledges cash generation was much stronger and net debt was reduced. The broker likes the new data that reveals cross shoppers are increasing across the retail and veterinary divisions.
Greencross reports the number of customer who shop in retail stores and use the veterinary services now amount to 3.5% of active customers The company will increase the number of retail stores that are co-located with a clinic to 30 by the end of FY17. Longer term Greencross plans to roll out over 350 retail outlets and veterinary clinics.
While Western Australia is materially weaker than the business on the east coast, UBS notes the sales performance has turned positive in the current quarter. The broker believes the City Farmers brand could be converted to Petbarn over time and, should this occur, there is material risk of goodwill impairment.
The broker expects inventories will build over the medium term as the company's private label is extended. Although gearing has eased, UBS notes, with the extension of debt facilities and the suspension of the dividend reinvestment plan (DRP), the company still has the highest leverage in its Australian retail coverage. Still, raising additional equity is considered an unlikely scenario. UBS retains a Buy rating with a $8.00 target.
Greencross is favourably positioned to fend off unwanted and opportunistically timed corporate approaches, Canaccord Genuity asserts, while capitalising on its market position. The broker notes significant improvement in net debt to equity ratios in the half year but expects some retracement in the second half. To this end, Canaccord Genuity takes comfort in the suspended DRP.
The broker also observe the co-located clinics are currently performing ahead of expectations, delivering revenues around $600,000 per annum per clinic. While these sites are in preferred locations, a material acceleration in revenue should validate the company's strategy and further insure against increased competition for some locations.
Another highlight is that 80% of retail sales domestically and 94% of NZ retail sales are on loyalty cards, which represents significant customer engagement and opportunity for cross selling, in Canaccord Genuity's view.
Upside to retail margins is expected going forward as the dilutive impact of new stores continues to reduce. The potential for margin expansion is also enhanced by the progressive lift in private label product, which the broker notes reached 18% of retail sales in the first half. Management has a long-term target of 25% but Cannaccord Genuity suspects this will take time to achieve.
Making only modest medium-term change to forecasts, including a reduced expectations for future DRPs, the broker increases valuation and target marginally, to $9.15 from $9.05. Buy rating is unchanged.
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