Greencross Limited (GXL) – NEUTRAL
COMPANY DATA
| Date of Report | ASX | Price | Price Target | Analyst Recommendation |
| 22/08/18 | GXL | A$4.01 | A$4.20 | NEUTRAL |
| Date of Report 22/08/18 | ASX GXL |
| Price A$4.01 | Price Target A$4.20 |
| Analyst Recommendation NEUTRAL | |
| Sector : Consumer Discretionary | 52-Week Range: A$3.84 – 6.56 |
| Industry: Specialty Retail | Market Cap: A$478.1m |
Source: Bloomberg
INVESTMENT SUMMARY
We rate GXL as a Neutral for the following reasons:
- Significant network around Australia, with a well-known brand name – ~247 stores.
- Increased focused on integrated locations – vet clinics and retail shop combined should increase GXL’s share of wallet.
- Increased education and pet ownership should continue to drive demand for veterinary services – Australia has one of the highest global pet ownership rates.
- New CEO has reset market estimates and Company strategy, which could yield improved top line and earnings growth for the Company.
- Bigger focus on data analytics and increasing engagement from GXL’s 1.8 million active users.
- Potential corporate activity – recent transactions have traded at attractive multiples. International player PetCo currently owns ~3% of GXL.
- Industry is expected to grow between 2-3% per annum.
- Expansion into overseas markets could provide a step change in earnings profile.
We see the following key risks to our investment thesis:
- Changing living preferences – more families are renting (restrictions around keeping pets) and living in high-rise buildings.
- Increased competitive pressures, particularly if Amazon launch a pet food/care service as they have done in the US.
- Significant decline in pet ownership.
- Recession in Australia – leading to reduced disposable income.
- Execution risk with opening 20 stores p.a.
- Value destructive acquisition.
ANALYST’S NOTE
GXL’s FY18 results were mostly in line or slightly ahead of expectations, with underlying EBITDA $97.6m a touch below estimates of $98.6 (but in line with our estimates), underlying NPAT of $37.2m ahead of estimates of $37.0m and EPS of 31.5cps was slightly ahead of consensus estimates of 31.4cps.
Further management noted that sales momentum has carried into FY19, with group revenue up +8% and like-for-like sales growth up +5.8%. We are cognisant of the trading pressures GXL faces from competition, however we are encouraged by the new management’s approach to balance sheet and earnings growth.
We continue to see merit in GXL’s integrated store strategy (retail + vet clinic) as a sensible long-term strategy. This should provide the Company a competitive advantage in what is a tough retail environment.
Further, the opportunity is significant to leverage off the 1.8 million active users, although execution risk remains. We maintain our Neutral recommendation.
- Focus on increasing existing spend from active users. Within this 1.8m active users, there are 60,000 HPP (Healthy Pets Plus) members who pay at annual fee of $440 p.a. The balance are members of the lift program in Australia and New Zealand. All customers average spends (not just loyalty customers) around $270 p.a. (for just retail) and visits the company stores average 5 times are year; on solely vet services, on average they spend $630 p.a. and visit around 4 times are year. Loyalty customers spend more than this on average. However, if the customers using retail and vet, then the average visits are 10-12 times per year, spending on average ~$360 on retail and ~$770 on vet services. Clearly if the customer is using both services at GXL, then they are more engaged versus individual services. Further, customers using retail, vet and grooming is spending around ~$1,450 p.a. and visiting 15 times are year. The key goal is to improve the people across the spectrum (from retail or vet -> retail & vet / retail, vet & grooming) to get an increase wallet of share.
- Operating cost savings on target. The Company is looking to remove from its cost base in order of $10-13m in operating cost p.a. However, as we have previously noted we would caution against assuming that all of the $10-13m will drop to the bottom line, as the Company is likely to reinvest some in price and growth initiatives. Management on the analysts’ conference call noted that they plan to reinvest $3-5m of this cost savings into the business.
- FY18 revenue. Group delivered solid top line growth of +7.5% in FY18, with like-for-like sales growth of +4.9%. Management noted this momentum has continued into FY19 with year-to-date group like-for-like sales growth up +5.8%. Further, GXL’s integrated sites, retail stores with in-store clinics and other services, are delivering like-for-like sales growth of +8.5%. The group now has 54 integrated sites comprising retail stores with an in-store clinic.
- FY18 operating earnings (EBITDA). Despite solid top line growth, group EBITDA was down -6.5% on pcp, driven by -16.9% decline in Australian Vet earnings and +53.1% increase in corporate costs. Cost of doing business (CODB) as a percentage of revenue was higher across all segments, particularly Australian Vet due to the earnings pressure. Group operating costs were up +9.5% over the year.
FY18 RESULTS SUMMARY…
FY18 P&L compared to the prior year are presented in the table below.
Figure 1: GXL FY18 P&L summary 
Source: Company, BTIG estimates
Key points from the results release:
- Revenue. Group delivered solid top line growth of +7.5% in FY18, with like-for-like sales growth of +4.9%. Management noted this momentum has continued into FY19 with year-to-date group like-for-like sales growth up +5.8%. Further, GXL’s integrated sites, retail stores with in-store clinics and other services, are delivering like-for-like sales growth of +8.5%. The group now has 54 integrated sites comprising retail stores with an in-store clinic.
- Operating earnings (EBITDA). Despite solid top line growth, group EBITDA was down -6.5% on pcp, driven by -16.9% decline in Australian Vet earnings and +53.1% increase in corporate costs. Cost of doing business (CODB) as a percentage of revenue was higher across all segments, particularly Australian Vet due to the earnings pressure. Group operating costs were up +9.5% over the year.
- Australian Retail. Australian Retail underlying earnings growth was driven by +5.1% like-for-like sales growth, which was on the back of +3.1% growth in like-for-like transactions and increased basket size. Australian Retail gross margin also improved by 70bps to 47.9% due to higher promotional effectiveness and increased sales of private labels (company owned brands) products.
- Australian Vet. GXL reported +12.3% top line growth in Australian veterinary division, driven by the rollout of in-store clinics, clinic acquisitions and specialty and emergency acquisitions. Like-for-like sales were up +4.3%. However, whilst strong like-for-like sales growth in specialty hospitals and in-store clinics was a feature, like-for-like sales in stand-alone GP clinics declined by -2.2% on the back of lower visit numbers. Management noted that like-for-like sales in stand-alone clinics have now stabilized.
- Cash flow. Cash flow was solid over the year, with the Company achieving 101% EBITDA cash conversion, driven by favorable working capital movements.
- FY19 outlook. GXL has seen the solid top line growth in FY18 continue into FY19, with group like-for-like sales growth of +5.8% in the first 6 weeks of trading. Retail business has continued its strong sales momentum with like-for-like sales up +6.1%. Australian Vet like-for-like sales growth is up +5.2% year-to-date and like-for-like sales in stand-alone GP clinics have stabilized. As a consequence of the above, group revenue is up +8% in the first 6 weeks of FY19.
Significant opportunity in GXL’s active users…
Within this 1.8m active users, there are 60,000 HPP (Healthy Pets Plus) members who pay an annual fee of $440 p.a. The balance are members of the lift program in Australia and New Zealand. All customers average spends (not just loyalty customers), on average $270 p.a. (for just retail) and visits the company stores on average, 5 times are year; on solely vet services, on average they spend $630 p.a. and visit around 4 times are year. Loyalty customers spend more than this on average. However, if the customers using retail and vet, then the average visits are 10-12 times per year, spending on average ~$360 on retail and ~$770 on vet services. Clearly if the customer is using both services at GXL, then they are more engaged versus individual services. Further, customers using retail, vet and grooming is spending around ~$1,450 p.a. and visiting 15 times are year. The key goal is to improve the people across the spectrum (from retail or vet -> retail & vet / retail, vet & grooming) to get an increase wallet of share.
Management believes at the moment most of their clients are still using just retail services and there is a lot of scope to move up the wallet share. This is in part due to the company still rolling out services (medical and non-medical) in-store for customer convenience. There are currently 247 stores and only 54 in-store clinics, i.e. ~22% penetration. This needs to be higher in order to achieve higher wallet share. Grooming salons penetration is currently around 106 and needs to be much higher. Whilst the Company is not necessarily forecasting an increase in the 1.8m active users, they believe there is a lot more to be derived from the current active user base with the new CEO very focused on
1. More personalised content and
2. Better valuation proposition across all services. Further, the Company is going to have more targeted/tailored discounted sales offering rather than broad base discounting impacting group gross margins.
Figure 2: GXL store network 
Source: Company
Figure 3: GXL Financial Summary 
Source: BTIG, Company, Bloomberg
COMPANY DESCRIPTION
Greencross Limited (GXL) is an Australasia leading specialist retailer of pet food, pet related products and pet accessories and also operates Australia’s largest veterinary services business. Key segments:
1. Retail – Greencross is Australasia’s leading specialty pet care retailer with over 230 stores, operating under the brand names of Petbarn and City Farmers in Australia and Animates in New Zealand.
2. Veterinary Services – Greencross owns and operates Australia’s largest network of veterinary practices with over 160 clinics including general practices, specialty and emergency centres, pathology labs and pet crematoria.
Recommendation Rating Guide
| Recommendation Rating Guide | Total Return Expectations on a 12-mth view |
| Speculative Buy | Greater than +30% |
| Buy | Greater than +10% |
| Neutral | Greater than 0% |
| Sell | Less than -10% |
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