Australia | Jun 11 2015
By Greg Peel
Macquarie was surprised last month when Greencross ((GXL)) provided a slightly disappointing trading update at the broker’s week-long conference, featuring presentations from a raft of invited companies. The broker has been a fan of Greencross since initiating coverage in March last year, and despite the disappointment maintains an Outperform rating.
Macquarie has until now been the only FNArena database broker covering the stock, and believes Greencross is still on track for strong profit growth. Greencross has established a dominant position in the pet services market, operating veterinary clinics and big-box format pet retail stores Petbarn and City Farmers. Australians love their pets, in increasingly growing numbers it would seem, and do not mind spending money on them.
Management downplayed what was effectively an earnings downgrade in May by noting Western Australia is suffering from weaker trading conditions, post the iron ore price collapse, and that second half trading was impacted by the severe weather experienced in the period by Queensland and New South Wales, which meant disruptions to the group’s supply chain just at a time a new third party warehouse management system was being implemented.
As a result of the downgrade Macquarie pulled its target price back to $7.50 from $8.50 but, noting the share price response to the news at the time, noted the stock had pulled back to the market PE multiple on FY16 forecasts and hence an Outperform rating was still justified.
Deutsche Bank has now elected to initiate coverage of Greencross, noting the pet care market has shown above average growth over an extended period – a trend which is expected to continue, driven by an increasing focus on premium pet product and services. But while Greencross might be sitting in the big box seat, so to speak, Deutsche is concerned by the company’s pace of growth through acquisitions and new store rollouts.
With rapid growth comes increased risk, and in Greencross’ case, high gearing levels. Deutsche took the company’s downgrade to potentially be a signal of further issues ahead beyond simply that of stormy weather.
The pet care market has been growing at an annual compound rate of 5% over the last decade. This is not simply a reflection of a growing number of pet owners, but of a structural shift towards premium products for pooch and pussy. Greencross’ strategy of acquisition and consolidation leaves it well placed to improve on the 8% market share the company currently maintains. Deutsche is forecasting a 14% compound annual growth rate for the company out to FY18, driven by the expansion of its store and clinic networks, co-location of stores and clinics and increased penetration of private labels and exclusive brands.
In FY15 alone, Greencross has increased its retail network by a staggering 49%. Over four years, the network has tripled. Deutsche Bank is concerned the earnings downgrade may be symptomatic of aggressive expansion which may provide for further near term pressure. Supply chain disruptions served to highlight a lack of an integrated supply chain to service the fast-growing network. A ratio of 2.8x net debt to earnings also concerns the broker as it allows little room for error.
Deutsche has set its FY15 earnings forecasts at the low end of management’s guidance range, some 11% below consensus which sits at the high end. The broker has set a $7.00 target and decided that risk and reward are currently balanced for Greencross, hence a Neutral rating is appropriate.
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