Small Caps | Aug 12 2015
-Sales growth slows in recent weeks
-Potential competitors ramping up
-Is gearing too high?
By Eva Brocklehurst
Greencross ((GXL)) has developed a dominant position in the provision of veterinary clinics and pet care products. The market continues to grow and the company is well placed to leverage this growth, although there are some issues for brokers in terms of bedding down acquisitions from FY15.
Deutsche Bank is concerned about the pace of growth, driven as it is by acquisitions and the rolling out of stores. Risks are compounded by high gearing. The company operates Australia's largest specialist veterinary services and pet retail group, with brands such as Petbarn, City Farmers and Animates.
The market offers favourable dynamics but Deutsche Bank remains concerned about the execution of the company's strategy, preferring to witness some stability before adopting a more positive view. The broker maintains a Hold rating and $7.00 target.
The financials were generally in line with expectations in FY15. Revenue rose 45%, driven by expansion in the network. Gross margins and the New Zealand business stood out as the most positive aspects, while there are signs Australian retail growth has slowed over the last quarter. Sales growth was primarily driven by the acquisition of City Farmers as well as the roll out of stores. NZ growth, at 8.0%, was attributed to increased traffic and premium product.
The recent downgrade to the outlook and the underperformance of City Farmers – which is heavily exposed to the Western Australian economy – as well as supply chain disruptions are aspects which disturb Deutsche Bank. This may just be a result of the aggressive expansion underway, the broker acknowledges, but the supply chain is not integrated and this is compounded by high gearing and thin cover for fixed charges.
FY15 was a period of significant investment, Macquarie observes. Operating cash flow was weak but it did include acquisition costs and significant investment in new stores. Macquarie believes the company has sufficient capacity and flexibility in its existing facilities to support the current growth profile and expects FY16 to be cleaner. An Outperform rating and $7.60 target are maintained.
Revenue synergies from the original merger of the pet and vets formats should be of material benefit from FY16/17, in the broker's opinion. Macquarie does acknowledge that the listing of National Vet Care, if successful, would mean a second aggregator in the industry emerges with reasonable scale and access to future funding. Still, in isolation, that company is not expected to drive a step-change in market multiples in the near term.
The success of Greencross means the broker is not surprised new entrants are attracted to the market, with feedback indicating at least two other corporates are exploring various strategies to ramp up their presence.
The majority of pet foods are imported, typically purchased from Australian distributors in Australian dollars. This signals to Macquarie inflationary pressures are likely to be shared and price increases an industry-wide issue. In this aspect, Greencross has potential margin offsets from growth in private and exclusive brands which currently represent 13% of sales and are higher margin products.
Operating cash flow in FY15 was impacted by one-off costs and working capital issues so Canaccord Genuity is happy with the company's performance and does not have concerns around funding and gearing. The broker believes, given the strong results, that these concerns will subside as investors renew their focus on the outlook.
Strong like-for-like sales growth is expected to feature, despite the challenging conditions emerging in the second half from weather and supply chain issues.Gearing levels will plateau and at 56% in terms of net debt to equity gearing is manageable, in the broker's opinion. Canaccord Genuity has a Buy rating and $9.15 target.
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