UK Edition
The best time to buy shares is when markets are most pessimistic. Weak investor sentiment means high-quality companies trade at low prices that offer significant potential for long-term capital growth.
Retailers are among the most out-of-favour companies at present. Investors are deeply concerned about their prospects at a time when consumer confidence has deteriorated to its lowest level since records began in 1974.
Since Questor has a long time horizon and often seeks to take a contrarian stance, retail stocks have rarely looked more appealing to this column.
Indeed, one of our previous tips, Pets at Home, has fallen by 38pc since a record high in September last year. It now trades only 4pc higher than where we tipped it in February 2020, although it has outperformed the FTSE 250 index, of which it is a member, by around 13 percentage points since then.
As a reminder, the company sells pet foods and accessories from 457 shops across Britain. It also offers services such as grooming and veterinary appointments.
This model offers considerable cross‑selling opportunities that have not yet been fully exploited. Only 27pc of the company’s 7.3m loyalty scheme members used its services in addition to buying food or accessories last year. While this represented a 22pc rise relative to the previous year, it shows there is substantial revenue to be won from existing customers.
The company’s online presence aligns it with the evolution of the retail sector. Over the past 15 years the proportion of retail sales conducted digitally in Britain has risen from 3pc to 26pc. We expect this trend to persist and to propel Pets at Home’s digital sales, which grew by 18pc last year and now account for 16pc of the total.
With a new distribution facility due to open next year and further efficiencies expected from an ongoing switch to local order fulfilment as opposed to national distribution, the company’s online margins could grow.
Crucially, the business has a sound financial position from which to invest in its long-term growth opportunities. Its net-debt-to-equity ratio including lease liabilities was just 30pc last year, while net interest payments on its debt were covered 11 times by operating profits. Such a solid balance sheet highlights its capacity to survive an uncertain period for the retail sector.
Its ability to navigate economic threats is further enhanced by the relatively inelastic nature of demand for pet-related products and services.
They are viewed as a staple, rather than discretionary, item by many pet owners, which means they provide substantial scope for price increases to accommodate rising input costs.
Moreover, rent renegotiations that have led to an average reduction of 25pc over the past year suggest that the company’s margins are likely to remain relatively healthy.
Separately, the business recorded growth in monthly subscription plans of 23pc last year. Since they now account for 9pc of total revenue, sales are likely to prove relatively sticky in an economic downturn.
Moreover, 40pc of its products are private labels that are typically 25pc to 30pc cheaper than rival branded products. They could further shore up the company’s financial performance if customers look to cut spending in the coming months.
A first-quarter trading statement due on Aug 5 will update investors on the company’s recent sales performance and will be the first quarterly update since a change in the company’s chief executive.
While management change always represents a risk to any company’s prospects – they represent a “known unknown” – Pets at Home’s price-to-earnings ratio of 13.1 suggests that the shares currently offer a wide margin of safety.
In Questor’s view, the company’s long-term growth potential and capacity to survive a period of weak consumer confidence are not well reflected in its market value.
True, investors may become more pessimistic in the short run over its prospects amid ongoing uncertainty about the retail sector. But on a long‑term view its share price fall means there is considerable potential for capital growth from current levels.
Questor says: buy
Ticker: PETS
Share price at close: 321p
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