-Shares fall 11% on broker downgrade

-Business has defensive traits

-Earnings expectations for 2023 are modest

Shares in pet supplier Pets at Home (PETS) slumped 11% following a downgrade from market perform to underperform from broker RBC Capital Markets.

The broker has lowered the share price target from 330p to 280p.

A VALUATION ARGUMENT

The principal argument for RBC’s downgrade is valuation, with the shares currently trading on a 2023 prospective price-to-earnings multiple of 15 times.

RBC believes this is a challenging multiple given the more difficult macro-economic environment.

Rising inflation has squeezed households’ incomes and RBC believes this increase in the cost of living will make it increasingly difficult for Pets at Home to grow its earnings.

MOMENTUM REMAINS STRONG

Recent results suggest that momentum remains strong in both the retail and vet businesses.

As yet there have been no indications that consumers are changing their purchasing patterns in response to the cost of living crisis.

Management confidence was also reflected in their recent decision to launch a £500 million share buyback.

DEFENSIVENESS QUESTIONED

A key question moving forward is whether the ‘humanisation of pets’ is becoming ubiquitous.

This would make Pets at Home pricing increasingly inelastic (able to increase price without suffering an equal loss in demand).

Investment director at AJ Bell Russ Mould commented:

‘The shares have now fallen by 38% year-to-date despite pet products and services seemingly being a defensive industry.

‘Beloved dogs, cats and more need feeding whatever the economic climate and owners typically view healthcare in this area as a non-discretionary spend, so in theory Pets at Home should be doing well. However, the market doesn’t seem to share this view judging by the performance of its share price.’

According to data from Statista, 62% of UK households now own a pet compared with approximately 40% before the pandemic.

The group’s exposure to high ticket purchases is low.

Over 50% of retail sales relate to food, with other essentials including litter and straw accounting for a further 25%.

Pets’ accessories range is focused on low ticket items, with an average price point of £44.

LOW EARNINGS EXPECTATIONS

Expectations for fiscal 2022-2023 earnings progression are relatively modest with a consensus of 2% growth.

Earnings forecasts are more ambitious for fiscal 2023-2024 with consensus estimates in the 17% range.

Investment bank Berenberg estimates following today’s share price fall Pets at Home is trading on a prospective 2023 price to earnings ratio of 12.9 times, falling to 11 times in 2024.

DISCLAIMER: Financial services company AJ Bell referenced in this article owns Shares magazine. The author of this article (Mark Gardner) and the editor (Martin Gamble) own shares in AJ Bell.

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Issue Date: 04 Jul 2022