The market gave a downbeat reception to this morning’s half-year results from Pets at Home Group (LSE: PETS), marking the shares down by 7% in a couple of hours’ trading.
News that chief executive Ian Kellett is leaving to pursue other business interests after just three years may have spooked investors. But I suspect the main reason for the sell-off was Pets’ falling profit margin, which the firm expects to remain under pressure over the next year.
Despite this, my reading of today’s figures is that there’s still a lot to like about this business. I’m considering topping up my own position over the next few weeks.
Not bad at all
By selectively cutting prices on core merchandise such as pet food, Pets at Home hopes to attract new customers for its more profitable vet and grooming services.
This strategy seems to be working. Like-for-like merchandise sales rose by 3.1% during the first half, compared to 1.9% for the same period last year. Sales of services rose by 9.5% on a like-for-like basis, up from 8.7% last year.
The proportion of revenue earned from services rose from 14% to 15.2% during the first half. But the gross profit margin fell by 2% to 51.9%, as lower profit margins on merchandise outweighed stronger profits from services.
The company expects this balance to shift in the 2018/19 financial year when group profits are expected to rise. More rapid growth is pencilled in for 2019/20, when “high-single-digit” profit growth is forecast.
Today’s figures show earnings per share down by 10% to 6.5p. The interim dividend has been left unchanged at 2.5p per share, which looks affordable to me, despite lower levels of free cash flow.
With a forecast P/E of 12.2 and a prospective dividend yield of 4.6%, my view is that the shares could be a profitable buy at current levels.
A defensive giant
Another big-cap name that’s fallen out of favour with investors recently is defence giant BAE Systems (LSE: BA). In its most recent trading update, the company announced plans to cut 2,000 jobs in response to reduced demand for its Typhoon and Hawk fighter jets.
BAE shares have fallen by nearly 10% over the last three months. They now trade on a forecast P/E of 12.5, with a prospective yield of 4%. Is this cheap enough to discount the risks of a further slowdown in BAE’s business? I think it might be.
Making fighter jets is a high profile business for BAE, but it’s not the group’s only big earner. Management signed shipbuilding contracts worth £5.1bn during the first half of this year, along with a raft of other new orders for weapons systems.
Another growth area that’s often overlooked is cyber security. Cyber warfare is a reality, and the risks only seem likely to grow over the coming years. BAE is committed to this business and has the scale to invest, acquire rivals and manage large government contracts.
Underlying earnings at the defence giant are expected to rise by 5-10% this year. Analysts’ consensus forecasts suggest a figure of 43.3p, which should cover the expected dividend of 21.9p per share quite comfortably. In my view, BAE could be a good long-term income buy at current levels.
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Roland Head owns shares of Pets at Home Group and BAE Systems. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.