With slightly over half of households in the UK owning pets, the FTSE 250 company Pets at Home has a significant consumer base for its range of pet products, including toys, treats, and accessories. The company’s success surged during the pandemic pet ownership increase; however, as this trend subsides and the market faces rising costs and diminishing demand, investors are left wondering if holding shares in Pets at Home is prudent.

Last week, the stock experienced a decline of nearly 15% following warnings of an “unusually subdued” pet market for the first half of the financial year and expectations that this trend would continue into the latter half. The retailer and veterinary service provider has downgraded its profit forecasts, predicting only modest growth in underlying pre-tax profits this year.

The recent announcement of increased national insurance contributions in the October budget also negatively impacted market sentiment. Pets at Home, based in Cheshire and employing approximately 18,000 workers, expects an additional £18 million in costs, primarily due to a revised lower threshold for employer contributions, which has decreased from £9,100 to £5,000.

Despite these hurdles, Pets at Home maintains several positive attributes. Founded in Chester by Anthony Preston in 1991, the company now runs over 450 pet care centers across the UK, many of which feature veterinary services and grooming salons, in addition to offering animal sales, food, and equipment. Last year, the firm reported a pre-tax profit of £106 million on revenues of £1.5 billion.

Pets at Home is evolving into a comprehensive “unified pet care platform,” merging its retail services, grooming, and veterinary offerings through a newly developed app. This integral approach has required significant investment in digital infrastructure, distribution networks, and physical locations.

Notably, the integrated model showed resilience in the first half, posting a 1.6% increase in like-for-like revenue to £789 million and a 14% rise in underlying pre-tax profit to £55 million, primarily driven by its veterinary sector, which, while smaller than retail, contributed £41.5 million to the pre-tax profits.

Although the veterinarian segment is a key growth area for Pets at Home, it is not without its risks. The Competition and Markets Authority is currently examining pricing and competition within the veterinary industry. There were no recent updates on this investigation, but Pets at Home asserts that it will not impede its growth strategy in this sector.

Pets now trades at a ratio of just 11.4 times its expected earnings, significantly below its five-year average of 19.1. The company boasts a robust business model that holds a leading market position in pet care and is well-placed for future growth as the pandemic-era surge in pet ownership leads to aging pets requiring more care. This scenario may attract attention from private equity firms, already significantly invested in the pet sector. The share price decline is noteworthy, with an anticipated dividend yield of 5.8% for the next year, surpassing the FTSE 250 index’s yield of 4%. In addition, the free cash flow yield is noted at 9%.

Last year, this publication recommended a cautious stance on Pets at Home shares as the investment in its expansion posed potential margin compression. Since then, the stock’s value has diminished by almost 20%. While the immediate outlook remains uncertain, making the ambitious mid-term target of 10% growth in pre-tax profit challenging, the historically high capital expenditure for business investment continues.

Dunelm Overview

Consumer confidence indicators in Britain are mixed at present. Weak retail sales suggest shoppers may be tightening their belts, yet Dunelm’s recent quarterly results showed robust demand for new furniture, countering this narrative.

In October, Dunelm reported a 3.5% year-on-year increase in quarterly sales, reaching £408 million for the period ending September 28, bolstered by an expanded product lineup. Competitor DFS Furniture has also seen significant demand for sofas.

Signs of revival in the home furnishings sector are evident, but the timing for a broader consumer recovery remains unclear. Dunelm noted it continues to face “volatile trading conditions” during the first quarter.

Nonetheless, the company aims for growth, targeting a 10% market share in the medium term by expanding its product assortment and opening new locations. Its recent acquisition of Home Focus, a homeware group in Ireland, offers a new entry point into a lucrative £1 billion market.

Dunelm, a family-run enterprise that originated as a market stall in 1979 under the leadership of Bill and Jean Adderley, still retains family ownership with a 45% stake in the business. Although their son, Sir Will Adderley, sold shares worth £114 million in September, he reiterated his commitment to the company’s future growth, stating that the sale aimed to diversify his investments.

This publication previously rated Dunelm as a buy in February, and the stocks have since returned a total of 9.9%. Trading at a relatively modest 14.6 times forecast earnings, the company faces some uncertainty due to consumer sentiment but maintains a solid growth strategy. Additionally, shares are expected to yield a notable 4% over the next year, making Dunelm a viable investment option at present.

Advice: Buy
Reason: Strong growth potential and appealing yield.