2023-03-22 18:58:55 ET
Summary
- Petco Health and Wellness Company, Inc. has seen growth come to a standstill following the pandemic.
- While sales keep rising amidst inflation, EBITDA is flat, as earnings fall amidst more asset-intense operations and higher interest expenses.
- This means that adjusted earnings are set to fall meaningfully and continuously, with aggressive adjustments and debt still making me cautious here.
Shares of Petco Health and Wellness Company, Inc. ( WOOF ) have fallen to fresh lows, which does not surprise me as I called the situation not convincing in December of last year. This came after the company had cut the full year guidance in a big way, and despite the solid secular trends and apparent modest valuation, I was fearful about a continued retreat, not being impressed with the quality of the business as well.
A Recap
Petco Health and Wellness Company, Inc. was founded in the 1960s to deliver a wide range of products and services to animals. The company targets a huge market, with 70 million U.S. households having a pet, translating into a more than $100 billion market opportunity, mostly comprised out of food, but now care, insurance and other services as well, with discretionary spending on these categories on the increase.
These secular growth trends accelerated during the pandemic of course, but the quality of the underlying business was a bit concerning to me, with negative organic growth reported in 2016, 2017 and 2018. The boom following the pandemic meant that the company saw a window of opportunity to go public at $18 per share in 2021, as private equity owners found an opportune time to sell.
Pre-pandemic, the company posted $4.4 billion in sales in 2019 on which operating profits of $129 million were reported, resulting in very slim margins. 2020 sales rose to $4.9 billion with EBITDA improving to $484 million, as adjusted earnings came in at $0.28 per share.
Sales rose to $5.8 billion in 2021 as EBITDA rose to $591 million and adjusted earnings rose sharply to $0.91 per share, or $0.72 per share if we adjust for stock-based compensation expenses. This results in higher earnings multiples, as net debt fell to $1.45 billion, for a 2.5 times leverage ratio.
The company guided for 2022 sales to rise further to $6.2 billion, anticipating EBITDA to improve to $637 million, with adjusted earnings per share seen around a dollar per share. After reporting a mere 4% increase in first quarter sales and flattish earnings, there were clear risks to the guidance. This was recognized by the market as a >$20 stock since the IPO level to the $15 mark early in the summer. Ever since, shares have fallen further, down to $11 in December as the anticipated weakness was seen in the quarterly performance.
The company cut the full year guidance alongside the second quarter results, with sales now seen at $6.0 billion, EBITDA down to $587 million, and the adjusted earnings being cut to $0.79 per share, as net debt was stable around $1.5 billion. Following the third quarter results, the company cut the earnings guidance two pennies further to $0.77 per share, as the lower EBITDA performance made that leverage ratio rise modestly to 2.6 times.
With realistic earnings seen at $0.60 per share, adjusted for stock-based compensation expenses, valuations were reasonable at $11 in December, but momentum and perceived quality makes me a bit cautious. Moreover, cash flow generation was held back on the back of net capital investment requirements and aggressive adjustments made to earnings, as inflationary pressures were not entirely observed by the business.
The Fourth Quarter Numbers
While a 5.3% comparable sales growth number for the final quarter of 2022 looks strong, the reality is that reported revenues only rose 4.2% to $1.58 billion in a generally inflationary environment. This is seen in the margin picture as adjusted EBITDA fell over a percent to $170 million, pressuring margins in a bigger way.
For the year, revenues rose 4% to $6.04 billion, with EBITDA down 1.5% to $582 million and adjusted earnings down sixteen cents to $0.75 per share. This includes a pre-tax $0.22 per share stock-based compensation expense, meaning that realistic earnings come in at a range of $0.55-$0.60 per share, as the company has made further aggressive adjustments. GAAP earnings came in at just $0.34 per share. Net debt was cut in a minor manner to $1.45 billion, badly needed as there is some pressure on EBITDA here.
More stagnation is seen in 2023 with sales seen up modestly to $6.15-$6.27 billion, which is not a big achievement in this inflationary environment, with EBITDA seen flattish. Amidst flatfish EBITDA and more expenses hitting the bottom line, adjusted earnings are seen down by $0.17 per share at the midpoint of the guidance.
This works down to an estimated $0.58 per share, for a realistic earnings number which likely comes in at less than $0.50 per share, after accounting for stock-based compensation expenses and other expenses as well. This is the case, even as 2023 includes an additional week. Moreover, the business will likely see continued net capital expenditures, with capital spending seen between $225-$250 million, comparing to a $194 million depreciation charge in 2022.
With 266 million shares now trading at $9 per share, the market value of Petco Health and Wellness Company, Inc. has fallen to $2.4 billion, with the enterprise value still up to $3.8 billion as debt remains substantial and has not really come down.
Reiterating Caution
While I am naturally attracted to a situation in which shares hit a new low, that is now the case here with Petco Health and Wellness Company, Inc. The 2023 guidance is underwhelming. While stabilization is seen in sales and EBITDA, more net earnings pressure is seen as the business has invested more in assets and sees higher interest rates amidst a reasonable debt load. The resulting $0.50 per share, or even lower earnings power, means that the fundamental support is still not seen here, as I do not see any quick gain for Petco Health and Wellness Company, Inc.
For further details see:
Petco Health and Wellness Company: Still Barking Here