According to various reports, the UK spends between £5bn and £11bn each year on its pets. Dog owners spend the most with an estimated average spend of £1,252 annually per pet.
The UK pet business is big business, and it’s improbable that the industry will go through any recession, even during periods of economic hardship cats and dogs still need to be fed and groomed. Against this backdrop, Pets at Home (LSE: PETS) seems like a great investment.
Unfortunately, over the past year its shares have dived as the company has struggled to meet lofty City expectations for growth. After four years during which pre-tax profit rose from £22.5m to £95.4m, for the fiscal year ending 31 March 2018, analysts expect profit to fall by around £10m to £85.6m and earnings per share to decline by 10%.
Despite its large target market, Pets at Home is facing increasing competition, but as the UK’s largest pet-focused business, it is uniquely positioned to grab back market share. Management has unveiled several initiatives to bring customers into the company’s stores, including changes to branded food lines and price cuts on various items. The group is also becoming a one-stop shop for pet owners by placing vet practices and grooming salons in its stores.
Nonetheless, despite these actions to try and turn around business performance, the shares have continued to trend lower. Luckily, after these declines, the business is trading at a desirable 11.9 times forward earnings, 25% below the average multiple of 15.9 times earnings awarded to the company since its IPO. As well as the discounted valuation, the shares also support a dividend yield of 4.6%.
As well as Pets at Home, Gama Aviation (LSE: GMAA) also looks to me to be an undervalued stock. After several years of lacklustre performance, Gama’s fortunes picked up last year as the company’s growth effort started to pay off.
Pre-tax profit hits £19.3m for 2016, up 180% year-on-year and significantly above the pre-tax profit of £520,000 reported for 2012. Between 2012 and 2016, revenue expanded from £17m to £203m. Analysts expect Gama’s new-found profitability to continue for the next few years with earnings per share of 25.9p pencilled-in for 2017 and 28.6p for 2018. Based on these figures, the shares currently trade at a forward P/E of 9.3, falling to 8.4 for 2018.
Compared to sector peers such as Air Partner, these multiples appeared to undervalue the business severely. Indeed, shares in Air Partner currently trade at a forward P/E of 15.1, and while Air Partner’s growth is faster, there’s no clear reason why Gama should trade at a near-40% discount to its peer.
A revaluation to a more appropriate multiple of around 12 times forward earnings would send shares in Gama up to 311p, 27% above current levels. It may take time for the market to realise the potential here, but luckily investors will be paid to wait. Shares in Gama currently support a dividend yield of 1.1% and the payout is covered 10 times by earnings per share, leaving plenty of room for payout growth.
Looking to give up work forever?
Buying undervalued stock, or value stocks has been a winning strategy for decades. Many of the world's best investors have used a value strategy to boost their returns and adopting such a strategy could produce huge returns for your portfolio.
If you're looking for more investment tips, our analysts have recently put together this brand new free report titled The Foolish Guide To Financial Independence. The report is entirely free and available for download today.
Rupert Hargreaves owns shares in Air Partner. 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.