Morningstar has welcomed a private equity takeover bid for pet and vet retailer Greencross, trimming its fair value estimate in line with the offer, which it expects will go ahead.

The offer from TPG Capital Asia values Greencross at $5.55 a share, and Morningstar analyst Daniel Ragonese has adjusted his fair value estimate accordingly - a slight reduction from the previous FVE of $6.

"We view this as a pleasing outcome, and the price appropriately reflects the quality of the business," Ragonese says, "largely supporting our positive view on the stock at the previous depressed price levels."

"We expect the takeover to proceed, hence we have adjusted our FVE to $5.55 per share in line with the offer price."

At midday Sydney time, Greencross (ASX: GXL) was trading at $5.39.

TPG's offer comes after an earlier bid two years ago, which Greencross rejected because it saw the $6.75 price as undervaluing the company.

However, Greencross chief executive Simon Hickey says the industry has changed in that time and that the emergence of online retailers such as Amazon and Chewy had boosted competition.

Greencross has about 250 retail stores, which also offer grooming, washing, boarding, and adoption as well as 200 vet clinics.

While the offer price is slightly below Ragonese's intrinsic valuation on a stand-alone basis, he says it provides shareholders with certainty of cash in the near term, especially as a higher offer from another suitor is unlikely.

Reasons to be bullish

Australia has one of the highest levels of pet ownership in the world, with about two out of three households owning a pet. Half of these households consider their pet as a member of the family.

Greencross pet care article vet

Pets are increasingly seen as a member of the family. Photo: © Ruth O'Leary | Ruthless Photos; Greencross

This "humanisation" is also a reason to spend. The pet industry in Australia is estimated at $9.5 billion. Up to $2.6 billion of this amount is spent on vet services, $4.5 billion on food, and the rest on other associated products such as insurance, grooming and crematoria.

"Total expenditure on pet food and veterinary services has grown at around 3 per cent per year, and in our opinion, should continue to outpace inflation," Ragonese says.

"The humanisation of pets and premiumisation of pet food and supplies is a long-term tailwind that is likely to continue over the long term. Greencross is relatively well placed to benefit from this trend."

However, keeping the competitive wolves at bay is difficult, Ragonese adds.

He attributes no moat to Greencross because of the threat of supermarket rivals such as Coles, Woolworths and Aldi, which he says are "sufficiently equipped to meet evolving consumer preferences."

"Greencross's vet division, which generates around one third of group earnings, has less operating leverage than the retailing division, with employee expense making up a large cost component," Ragonese says.

"As such we see limited scope for margin expansion by increasing the number of vet practices, and we project flat margins for the foreseeable future."

For the five years to fiscal 2023, Ragonese forecasts 7 per cent earnings per share growth.

Greencross at a glance:

Bulls say:

  • Consumers see pet spending as non-discretionary. Even in the GFC pet spending was resilient. 'Humanisation' of pets, premiumisation of products, and increased spending per pet should support growth
  • Few retailers match Greencross’s integrated business model, variety of products and services
  • Greencross has ample opportunity to make well-priced acquisitions, roll out stores and consolidate the industry in the next decade

Bears say:

  • Fragmented market with few barriers to entry. Competitors could therefore roll out stores and replicate Greencross's model
  • Supermarkets have a presence and scale in the pet category and may choose to price pet consumables as a loss leader to drive traffic
  • A decline in pet ownership in Australia would reduce the size of Greencross’s addressable market

 

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Lex Hall is content editor, Morningstar Australia

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