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Morningstar | Greencross Remains Attractively Valued Despite Recent Share Price Appreciation

Despite no-moat-rated Greencross’ share price jumping almost 20% during the past week, on the back of corporate activity speculations, we continue to believe the stock is undervalued at the current price. The company is a leading player in the Australian pet care retailing and veterinary services, and in our view, the industry fundamentals are strong. The increasing humanisation of pets is a phenomenon driving premiumisation of pet food, uptake of additional services, and is likely support continued growth in expenditure per pet for the foreseeable future.

Greencross is well placed to benefit from these tailwinds, supported by its transition towards a one-stop-shop model. Currently, only 22% of its retail stores have a veterinary clinic, although within the next five years, we expect around half of stores will feature an in-store clinic, along with other services including grooming, washing, and boarding. We expect the integration of services within the retail store network to drive foot traffic, cross-selling opportunities and scale benefits. Early success of this strategy was demonstrated in the recent result with fully integrated retail stores delivering same-store sales growth of almost 9%, substantially higher than the 5% delivered by the retail business as a whole.

Following recent media speculation, Greencross confirmed it is in discussions with various parties regarding credible proposals. At this stage, the proposals are subject to several conditions and are nonbinding and incomplete. Our understanding is the interest is from various private equity firms, as the company has previously received and declined private equity bids. In any case, the interest is hardly surprising given the quality of the business, and the depressed stock price in recent months.

We’ve made some minor adjustments to our forecasts, however, on average, our earnings projections are broadly unchanged. We forecast EPS to grow at a mid- to high-single-digit pace (annually) on average, during the next five years. We’ve raised our revenue forecasts slightly to reflect higher same-store sales in both the retail, and in-store veterinary clinics. Same-store sales should grow at around 3-4% per year, supported by incremental growth in pet population, modest inflation, and increased expenditure per pet. The remaining revenue growth is a function of the ongoing rollout of in-store vet clinics, and market share gains.

The slight increase in our revenue projections is offset by a lower margin expectation. Despite growing private label penetration, we’ve cut our long-term EBITDA margin forecast by around 50 basis points to around 11.5%. This is slightly higher than current levels and reflects our expectation for additional reinvestment into price and digital capabilities. Over the long term, we expect private label penetration can reach around 40% of retail sales, up from 23% currently. While we estimate private label products offer around 10 percentage points margin uplift, the company will struggle to retain this, and the majority will be invested in price to help offset pressure from online players such as Amazon. We expect the retail cost of doing business to remain relatively steady, as the benefits of operating leverage are likely to be invested into the firm’s digital capabilities, service offering, price, and loyalty programs, to defend its turf in the face of Amazon and other online threats. There is scope for the in-store veterinary margins to increase as the firm is still in relatively infant phases of this expansion strategy, but in the initial years these clinics are margin-dilutive. At the group level, in-store veterinary margin impact is likely to be limited, given the pressure in retail.