If you’re searching for an example of how buying out-of-favour stocks can result in superior returns, look no further than retailer Pets At Home (LSE: PETS). Since the beginning of 2019, its stock has almost doubled in value. As a comparison, the FTSE 250 index (of which Pets is a member) has increased ‘just’ 11%.
Based on today’s trading update for the first quarter of its financial year (and the market’s reaction to it), I think there could be more to come.
“Slightly above expectations”
Hailing a “strong start to the year“, Pets reported a 9.9% rise in revenue to £303.4m over the 16 weeks from 29 March to 18 July. Interestingly, £266.4m of sales came from the company’s traditional bricks and mortar retail stores and only £26m from orders placed online, suggesting lots of room for growth in the latter going forward.
Although still making a relatively small contribution, revenue growth at its veterinary division, at £37m, was even better (+18.8%). This follows the “recalibration” of this part of the company during which Pets bought out 55 joint venture practices and marked over half for closure. According to the Wilmslow-based business, this process is now “largely complete“.
Thanks to the above, Pets now expects underlying profit for the year will be “slightly above current market expectations” with all other previous guidance left unchanged. On a day when markets are fretting over the latest development in the US/China trade war, it’s perhaps understandable that the stock was one of the few risers in early trading — up a little over 4%.
Although there can be no guarantees when it comes to investing in any company (and the probability that a few contrarian investors will decide now is the time to bank some profit is high), I continue to think that the £1bn cap could be a decent medium-term hold.
Defensive pick
Like fund manager Terry Smith, I’m generally positive on any investment opportunities relating to pets, simply because many people now consider their furry (or not so furry) friends an irreplaceable member of the family. This makes it very likely we’ll tighten the purse strings everywhere else in tough economic times before considering spending less on them, giving Pets At Home a rather defensive feel.
This is why I particularly like the fact that the firm is trying to take as big a chunk of owner spend as possible by offering a growing number of services in addition to the traditional retail offering. The recent partnership with Tailster.com — a site that allows people to find pet walkers and sitters — is a good example of this.
The strategy seems to be working too. Today’s statement included news that the number of VIP club members who bought both products and a service had grown 23% year-on-year. On top of this, the company stated that it now had 765,000 subscription customers (defined as those who have a health plan from its Vet Group or an arrangement with one of its omnichannel platforms).
Before this morning, shares in Pets were changing hands on 15 times forecast FY2020 earnings. Even if the company could only state that it was “cautiously optimistic” on its outlook as a result of Brexit-related uncertainty hitting the retail sector, this still looks fairly reasonable to me. There’s a forecast dividend yield of around 3.6% on offer, covered 1.8 times by expected profits.
