Stockwatch: why I’m buying value and selling this ‘growth’ play

Last February, I compared Pets at Home Group (LSE:PETS) and home improvement retailer Wickes Group (LSE:WIX), concluding the latter possibly had the better risk/reward profile – being a “value” play versus Pets’ assumed “growth” characteristics.

Essentially, sentiment was weak towards Wickes – meaning a low price/earnings (PE) ratio, high dividend yield (if you trust forecasts) - while expectations remained high for Pets on the rationale that “Britain is a nation of animal-lovers”. 

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Wickes’ stock has eased yet underlying rationale is firm 

A slower housing market could mean lower expenditure on upgrading, and the lockdown-inspired DIY boom is over. Yet I recall at least one recession when sales, for example, of kitchen and bathroom materials proved far firmer than expected, as enough people opted to refurbish than move. Our ageing UK housing stock has literally built-in needs for upgrading. 

At 158p, Wickes’ shares were on a PE of just over nine times, offering a near 7% yield, but they had still fallen below 120p by early July, currently 137p. Not to dismiss that drop, but I think it partly related to general disillusion with domestic equities plus the CEO speaking controversially on gender issues.  

A 25 July trading update in respect of Wickes’ second quarter to 1 July showed firm sales with costs under control; also cash generation enabling a share buyback programme besides the prospect now of an 8% yield (guiding for a 10.9p dividend). That could yet be compromised by an economic downturn, but six weeks ago at least, management was confident. 

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The sales improvement was hardly much: growth of 3.0%, which does not match inflation, but a marked turnaround from 1.8% contraction in the first quarter, which made Wickes’ first-half-year 0.7% positive.

Yet the outlook was described as “encouraging” on the basis of “further momentum in Trade as local traders use Wickes to save time and money” plus an improving trend in DIY and also the Do-It-For-Me side which helps with kitchen/bathroom design and installation. Mind, this latter operation has been quite volatile according to Covid, so if people become cautious again this winter it could be affected. 

Notwithstanding recession risks, I am inclined to keep a “buy” stance on Wickes for the long-term upwards mean-reversion to fair value.  

Its spin-off flotation two years ago disappointed, and the share price chart’s 200-day moving average shows no real uptrend as yet, although it is potentially at the bottom of a “bowl”. This aspect of retail is competitive, yet I think Wickes is well-positioned as a “value” operator.  

Wickes Group - financial summary
Years to 1 Jan, also 31 Dec

Source: flotation prospectus and company accounts.

Pets drops on probe into vets 

At 375p, Pets traded on a forward PE in the high teens, yielding just over 3%. I noted how vets’ prices have soared and said that, while insurance policies had absorbed this so far, “will people be able to afford (the implied) higher premiums in due course?”

I was generally cautious given Pets was exposed to the slightest deterioration in the narrative; also, its stock had had a great run following the actions of a CEO from 2018, then lockdowns boosting pet ownership. It had peaked at around 520p in September 2021 (like many) and was then volatile-sideways. Bulls were tired. 

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It fell nearly 13% early yesterday, closing down 9% at 343p – as investors tried to make sense of the Competition and Markets Authority (CMA) announcing a review of the UK’s £2 billion veterinary industry. This follows concerns that pet owners are not getting value for money or know what is justified when deciding treatment for pets now that the profession has more concentrated ownership.  

From Pets’ annual accounts to 31 March 2022, vet care represented less than 9% of group revenue, but a 42% pre-tax margin meant it contributed 37% of group profit. It is therefore important to why Pets’ equity has been rated strongly, with nearly two-thirds of the stores offering veterinary service. 

A long-term context of limited supply of vets 

Veterinary revenue grew over 16% in Pets’ first quarter to 30 June, this said to have been helped by an increase in vet capacity rather than prices. Later yesterday, CVS Group (LSE:CVSG) – an integrated veterinary services company – defended its pricing on grounds of a national shortage of vets. This would appear economically justified: Brexit for example saw EU workers return home; then Covid boosted pet ownership, hence demand for care; wages have had to rise to attract more into the profession. 

Even 40 or so years ago, doing my A-levels, I recall how demands to study veterinary science meant that only one chap in my school was able to get a college place for such. It was easier to become a doctor than care for dogs. 

I suspect insurance is also playing a part in care-pricing; apparently the first question vets ask is “do you have it?” And besides advances in veterinary science, this is supporting more complicated costly operations on older animals, where years ago such pets would simply have been put down.   

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A specific concern for the likes of Pets and CVS, however, is this CMA missile aimed precisely at commercial groups that have taken over smaller independent practices. While nearly 90% of vets practices were independent in 2013, this had shrunk to 45% by 2021. Such a concentration implies greater pricing power, so it is understandable that the CMA wants to investigate why pet-care pricing has soared faster than inflation. 

I recall Pets saying a few years ago that their acquisitions strategy suited partners of such practices well, given they faced a succession challenge when approaching retirement. I suspect they also appreciated a golden cash exit. Criticism became apparent (see online reviews) that a shift in veterinary practice culture under PLC ownership included financial targeting. 

It is a nuisance for stock sentiment. The CMA’s investigation into funeral pricing and practices took around three years and contributed to a cloud over Dignity before it was bought out. 

Risk of being seen as ex-growth  

This is happening in a context where Pets’ like-for-like quarterly retail revenue numbers improved progressively from 5.6% to 11.0% over its financial year to 30 March 2023.  

That seems initially re-assuring if vets profit growth is now in question. But, for example, if increased living costs bear down on households, then new pets are discretionary spending that’s easy to cut. Grooming services, which are everywhere nowadays, are arguably superfluous. Pets does not quantify its contribution from grooming except to say revenue was flat on the March 2022 year.  

Pets’ retail revenue therefore has defensive aspects, if possibly some elements are a bit exposed.   

My point being, on fundamentals this is looking like a consolidation story. It comes in the context of the stock trading volatile-sideways over the last three years. If a sense of “ex-growth” takes hold, the market may therefore price Pets for income – as realistic shareholder return – rather than capital appreciation.  

Pets at Home Group - financial summary
Year-end 31 Mar

Source: historic company REFS and company accounts

While retailing is fundamentally cash-generative and the table shows a good record of free cash flow, mind that it is quite flat. If Pets’ revenue/profit eases at all, dividend growth is out the window, hence the stock may end up falling further - partly to exact a higher yield. 

For example, if consensus for a 14p per share dividend is achieved in 2025, a circa 5% yield implies market price of 280p.   

A further dilemma is Pets coming across increasingly as a “weak hold”, which more aggressive investors could view as “sell”. In early dealings Friday, the share price edged down 1% below 340p. I am liable to get slammed by holders who regard this as a good business, but on a two-year view it may be better to consider switching, hence I now rate the shares a “sell”. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.