The Pets at Home boss, Lyssa McGowan, has been in charge for only six months. Her first task? Convince the market that profit growth will speed up again next year in the face of inflated operating costs and dwindling consumer spending.
The retailer has been hit by higher freight and energy costs and a slowdown in sales growth, which boomed during lockdown as customers splurged spare cash on pets. Adjusted profits over the 28 weeks to October 13 fell 9 per cent to £59.2 million, which means the company is banking on trading during the second half doing the heavy lifting to hit guidance for pre-tax profits of £131 million.
Pets at Home was a pandemic-era winner, priced for racy growth. Investors have become more cautious in the face of double-digit inflation, and that’s aside from the challenges buffeting the retailer’s margins.
The shares are priced at just under 15 times forward earnings, down from a peak of almost 30 towards the end of 2020 and below the average of 16 since the company’s float in 2014. But that reading might be too harsh. Spending on integrating its retail, veterinary and services, such as grooming, on to one website will weigh on profits this year, as will the cost of opening a new distribution centre early next year. But a capital expenditure bill of £100 million is expected to represent a peak. The rationale for spending on its digital operations is sound: increase the amount of revenue from each customer.
Freight costs have come down and management reckons rates will fall to pre-pandemic levels during the second half of the financial year.
The cost of heating and lighting its vast stores is a bigger headwind. The group’s fixed tariff ended in January and it hasn’t hedged its energy exposure. The energy bill is expected to total £22 million this year, compared with £8.5 million last year. That should wipe about £8 million from profits in the second half, in addition to £5 million in the first six months. Cutting rents by roughly 25 per cent on leases as they are renewed is one mitigating factor.
Like-for-like revenue growth of just over 6 per cent in the first half of the year was in line with expectations and came off the back of booming sales at the same time last year.
How customers respond to the rising cost of living is a bigger uncertainty. The wares Pets at Homes sells are not purely discretionary: food sales accelerated during the first half of the year, rising 15 per cent. But higher-margin sales of pet accessories fell by almost 4 per cent, which ate into the retail gross margin. Crucially, underlying profit guidance doesn’t assume that revenue accelerates during the second half, prudent given pressure on customer wallets.
Subscription services such as healthcare and easy-repeat food delivery plans, which account for just under a fifth of the group’s revenue, could help retain more of pet owners’ pounds. Underlying growth in higher-margin veterinary services, where Pets at Home takes a fee on revenue generated by the practices, has also maintained a higher level of growth than retail.
Analysts reckon that this year will represent a trough in terms of growth and have forecast underlying pre-tax profits of £136 million for the 12 months to the end of March 2024.
Net cash position amounted to £43 million in October. That should reassure investors that the company can pay a decent dividend, which analysts at Numis think will amount to 12p a share this year, which leaves them offering a potential yield of 4.1 per cent. If this year proves to be the bottom in terms of profit growth, the shares might be stirred higher.
ADVICE Buy
WHY A weaker valuation looks too harsh in light of the medium-term growth opportunities
HarbourVest
As investment trusts go, private equity specialists are pretty unloved. HarbourVest Global Private Equity is a case in point, with shares trading at a 38 per cent discount to the trust’s net asset value. There is good reason to be cautious towards the value placed on the underlying holdings of such trusts.
The link between assets managed by HarbourVest and private companies it seeks to mine for returns is a meandering one.
HarbourVest does not invest directly; it gains exposure to investments in, and portfolios of, private companies through funds managed by the US-based HarbourVest Partners. In turn, that private equity investment manager invests in funds managed by private equity heavyweights, such as KKR.
The trust’s net asset value fell just 3 per cent over the six months to the end of July, driven by a sell-off in its publicly listed holdings, which account for 8 per cent of the portfolio.
Inflation and interest rates were rising before July but not at the pace that they have since. Higher inflation and financing costs erode the value of private companies — and more highly valued technology companies in particular — a sector that accounts for about a third of HarbourVest’s portfolio. A more marked fall in the trust’s private holdings seems likely and is reflected in the discount embedded in the share price.
New investments outweighed the distributions received by HarbourVest over the first half of the financial year, which typically come either via IPO or when a company is bought. Activity on public markets is subdued but higher debt costs could erode the returns handed back to the trust if trade buyers barter harder.
The bedrock of HarbourVest’s investments is in buyout funds, partly designed to minimise the volatility typically delivered by venture capital investments in early-stage companies. Such companies account for just over a third of HarbourVest’s portfolio by value.
Over the past decade the trust has outperformed the FTSE All-World Index, generating a total return of 397 per cent but much of that was against a backdrop of anaemic interest rates and benign inflation.
ADVICE Hold
WHY The discount reflects the likelihood that the NAV will decline further
