Earnings Call Transcript - PSNY Q2 2022

Peter Pritchard, Group CEO

Good morning, everyone, and thank you for joining the call. I hope you're keeping safe and well. I am Peter Pritchard, the Group CEO; and with me today is Mike Iddon, our Group CFO. We're pleased to share with you our interim results for our financial year 2022. The strong performance across our veterinary and retail operations during the last year have accelerated throughout the past 6 months. And today, our business has never been stronger. This is reflected in the results we are reporting today, and I'm pleased to say that our performance continues to be strong across the group, demonstrating the ongoing success of our pet care strategy. There are 4 key messages to take away from today. The first and most importantly, we now see a pathway to GBP 2.3 billion of customer revenues over the medium term, a substantial increase versus our previous assessment. Sustained and continued growth in the impact over the past 18 months beyond our previous expectations is increasing the size of our addressable market and has led to a material step-up in the growth opportunity ahead. We believe that we are not yet past peak pet. This has reflected the elevated levels of customer registrations across our loyalty clubs, subscriptions and new client registrations in our vet practices. The sign-ups to our bespoke Puppy and Kitten Club have more than doubled year-on-year. These customers are incredibly valuable to us. Not only do they spend more with us, they also stay with us for longer. We continue to register nearly 10,000 new clients across our vet practices every week, supported by our in-store referrals and our puppy and kitten program. And the number of subscription plans across the group has grown 45% year-on-year to over 1.4 million clients. The company generated GBP 110 million in annualized recurring revenue, now representing 9% of total group revenue. Second, we are continuing to see strong growth across all key categories and channels. Our like-for-like group revenue increased by 22.2% year-on-year and 28.6% on a 2-year basis. All parts of the group are growing. In retail, our like-for-like grew by 21.9% year-on-year or 28.9% on a 2-year basis. And in our vet group, the like-for-like group on 26.2% year-on-year, that's a GBP 0.238 increase on a 2-year basis. In retail, our sales growth is broad-based with omnichannel revenue growth of 21.5% and like-for-like growth across stores of 21.1%. Strong sales growth translated into strong profit growth with profit before tax growing by over 77% to GBP 70.2 million. And today, we're also announcing a 72% increase in our interim dividend to 4.3p. Third, we are demonstrating the advantages of being a full-service omnichannel pet care business. And through these broad offerings of pet products and services across all our channels, Pets at Home is well placed to capitalize on full growth potential of the market. We're leveraging our growth in an in-house data capability, integrating analytics into our extensive pet data set to drive parallel insights that are increasing our share of wallet. This is now supporting our day-to-day decision-making because we're using intelligent data to support our decision-making across our longer-term strategic investments, which will drive sustainable, high-quality growth across our business. By combining the best of our unique pet care centers, supported by a best-in-class digital platform, we're giving customers a market-leading pet care proposition. We aim to have convenience of competitors, building on a base of 1-Hour Click and Collect, and contactless delivery services, which are all performing well, we're now using our pet care centers as mini-distribution hubs, improving capacity and reducing costs. Now the proximity of these centers to the vast majority of the pet and the population has enabled us to pilot the same-day delivery service, including the 2-hour home delivery service with plans to run nationwide in the second half of the financial year. We're driving practice maturity in our unique veterinary model, where strong sales growth has underpinned a significant uplift in profitability and cash flow. Best operating models across the industry haven't evolved for decades. And we've always been a disruptive player within this industry. We recently launched our new operating model, Pathfinder, into 2 new pet care centers. Pathfinder is designed to optimize clinical resources and improve client engagement and practice economics. Early results are very positive. We're now fine-tuning and we plan to roll out at full pace. Fourth, we continue to execute on our strategic investments building on capacity and capability across all pet care platforms. We are now in the build mode, with the Polestar, our GBP 20 million investment, which is digitizing the pet care experience, making it even easier for our customers. The initial phases will land in early 2022. We'll continue to roll out our next generation of pet care centers through our store transformation project, with 5 new centers launched so far this year, including one in Balham as we continue to build our presence within Greater London. Last week, we opened a brand-new pet care center in Brighton, which includes a significant number of environmental initiatives, which we plan to incorporate into our pet care centers as part of our pets, people and planet initiatives. And we continue with the development of our planned new storage and distribution facility in Stafford, which we broke ground on earlier this year, and it remains on target to go live in 2023. So in conclusion, our performance of the first half further demonstrates the strength of our unique pet care strategy and the robustness of the U.K. pet care market. We start here today as a far stronger pet care business, and we look to the future with a well-invested plan and confidence. We focused on running a successful business, but we also focused on running a good business too. We continue to do the right thing by all our stakeholders as we progress our journey to become the best pet care business in the world. And finally, I'd like to express my sincere thanks to all our colleagues and partners across the group, their time, work and dedication. The last 6 months have been challenging as the country emerges from lockdown, and the strong results we're reporting today would not be possible without their efforts. So I'll stop there. I'm sure there are going to be plenty of questions and Mike and I are here to answer them. So I'll now hand back to our call operator, Tracy.

Operator, Operator

We will now take our first question from Owen Shirley from Berenberg.

Owen Shirley, Analyst

The first was just a straightforward one on your latest thoughts on what you think the pet population is growing at now? And perhaps any thoughts on the outlook for that? Secondly, could you talk a bit about the learnings from the delivery in-store or delivery-from-store trial that you've carried out? Specifically, have you been charging for it, what's the elasticity like if this is the same-day delivery you've been doing that yet? Is it helping conversion rates? And how much money, how much cost is it saving on distribution? And then the third question was, if we assume the freight costs normalize back down at some point, when that happens, should we expect that to reverse into a gross margin tailwind? Or could it get reinvested in price, for example?

Peter Pritchard, Group CEO

Thank you. I'll address the first question regarding pet population and our insights from delivering from stores, after which Mike will discuss freight. First, we haven't observed a decline in new pet registrations. Annually, we gather market data to evaluate the pet population, and while we haven't conducted that assessment yet, I can share what we are currently experiencing. Our Puppy and Kitten Club registrations have increased year-on-year by over 100%, typically adding between 25,000 and 30,000 new members each week. Additionally, within our veterinary business, we're seeing up to 10,000 new client registrations weekly, with around 17% of those being first-time pet owners. These are robust numbers, consistent with what we reported six months ago, which may surprise some. However, many people tend to plan 8 to 12 months in advance to acquire a new pet, often working with breeders and waiting lists, amid a continued shortage of pets. This context helps explain the trends we’re observing. Our market fundamentally hinges on the total number of pets in the country, which continues to rise, indicating a positive outlook for the future. Regarding delivery from stores, we believe this operation could be transformative for several reasons. It allows us to utilize as many stores as needed as picking centers for customer orders, which comes with numerous advantages. First, each store carries over 6,000 SKUs, including many of our best-sellers, and is typically within a 15-minute drive from pet owners. This means around 95% of the U.K. population can access our pet stores conveniently. The benefits are multifaceted. Cost savings are significant; for example, fulfilling orders from nearby stores rather than distant distribution centers reduces transportation costs. Additionally, as our business expands and our central fulfillment centers reach capacity, we can distribute workload across our delivery network more effectively. Moreover, we can optimize larger stores' revenue potential by increasing product throughput while maintaining fixed costs. The most exciting aspect is our ability to enhance service offerings due to proximity to our customers. Last week, we initiated a pilot program for same-day delivery in 35 stores, with a two-hour delivery window available for customers within a 2.5-mile radius. Impressively, our first order from the Charleston store took just 20 minutes from order placement to delivery. This capability broadens our reach; when customers shop online, those who previously patronized our stores often double their spending. By providing more convenient options, we aim to increase our share of wallet with customers. Utilizing our entire network allows us to fulfill orders in the most commercially and economically viable manner, aligning with our customer commitments, and we anticipate these new choices will drive even greater revenue. As for the premiums, it's still early, but we continue to see increased share of wallet. It's worth noting that we typically capture around 37% of our customers' spending, up from 33% three years ago, reflecting significant growth during this period. However, we believe there is still considerable potential to expand beyond our current share. Growing our business with existing customers appears very promising, and we are well-positioned to attract new pet owners. Mike, could you take over regarding freight costs?

Michael Iddon, Group CFO

Yes. I mean you asked a question about freight costs. So overall, our group gross margin expanded actually in the half by over 100 basis points. That's in line with what we expected, driven by the growth in our Pet Group. But you're right to point out, weighing on our margin in our retail business, where the well-publicized increases in freight rates. So for us, in the first half, they were around GBP 6 million. So in terms of group gross margin, that had an impact of about 90 basis points on our group gross margin. We're planning for pretty much the same level in the second half, actually, and that's all in our guidance for the full year. As we look into next year, we don't see any sign actually of those freight rates actually improving, so maybe they'll be here for a little while to come. You asked the question though, if it reverses, what do we see an improvement in gross margin, and would we then invest that in better pricing? I wouldn't make the connection between our pricing decisions and the requirement for freight rates to reverse. We will remain competitive on prices regardless of what freight rates are. We're not going to give any oxygen to any of our competitors by being out of line on pricing. If the freight rates do go back to normalizing, we would expect our gross margin to improve in our retail business. But don't make the connection between that and putting our prices lower, being dependent upon freight rates getting lower. We look at those 2 things completely separately.

Operator, Operator

We will now take our next question from Manjari Dhar from RBC.

Manjari Dhar, Analyst

Firstly, can you provide details on the proportion of staff trained in the store pick model and the go-to store video functionality? Secondly, regarding cross-selling, I noticed that 27% of VIP customers shop across more than one channel. Do you have insights into how this varies between online and in-store cross-selling for the retail segment?

Peter Pritchard, Group CEO

I will address the first question regarding colleague training. We have a distinctive method for rewarding our staff. Essentially, the more knowledge and expertise you gain, the higher your pay. This is reflected in the fact that 63% of our colleagues earn a real living wage rather than just the national living wage, as we compensate you more as you complete your training and prove your value to us. Interestingly, we do not market this approach, nor do we believe that selling is the best strategy; instead, we focus on providing quality advice that leads to sales. Our colleagues are present on the shop floor, and we do not permit them to engage with customers unless they meet our basic knowledge standard, which allows them to have meaningful conversations about various pet topics. After that, they undergo specialized training in areas like nutrition or reptiles. Through our going store technology, we connect customer inquiries directly to in-store experts. With many of our staff trained to a high standard, we can efficiently route those inquiries. Early observations show that this model is driving an increase in basket premiums. New pet owners, particularly those with puppies and kittens, are responding positively, resulting in higher spending with us. Regarding cross-selling, you're correct in noting that we conceptualize this in terms of customer engagement with our services, referred to as plus 1. Currently, 27% of our VIP members participate in at least one service, which represents a 19% growth year-on-year. This reflects our strategy of understanding pet customers' needs and guiding them toward solutions, which ultimately enhances our offerings. Coupled with valuable insights, our ability to segment customers and anticipate their needs enables us to execute effective CRM campaigns and personalize experiences. While we don't disclose specific details, our services do enhance customer engagement and profitability, a trend we expect to maintain. Looking ahead to next year with Polestar, we anticipate significant opportunities to further personalize customer experiences on digital platforms by offering tailored recommendations based on individual preferences and pet needs. This promising development is something to look forward to in the coming year.

Operator, Operator

We will now take our next question from Simon Bowler from Numis.

Simon Bowler, Analyst

I have three questions, if I may. The first is about marketing costs and the investment related to gross margin. Is this now a cost line that will be structurally higher since you have a better understanding of the opportunities and returns on marketing spend? Or is it unusually high at the moment because there are fundamentally more new potential customers given the increase in puppy and kitten populations? The second question is about Slide 23, which I found quite interesting. It appears to be new disclosure where you analyze the components of pet care spending over the pet's lifetime. I was wondering if you could provide any absolute numbers that might accompany that chart, especially as you look at the early years of the pet's life cycle. Finally, you've increased your customer sales opportunity to over 900 but kept your medium-term guidance for veterinary free cash flow at GBP 60 million. I would like to understand why that is. Are those two figures related since both pertain to the medium term, or is there something we're missing here?

Peter Pritchard, Group CEO

Okay. Let me address the first question about cost. Mike and I will also tackle the questions regarding pet spending and veterinary free cash flow. You're correct in noting the gross margin in retail. While Mike mentioned freight costs, another factor is the discount related to puppies and kittens, where we provide customers with a 10% discount on their first purchase. We consider that a discount as it reflects the marketing cost contributing to gross. This strategy is effective in creating substantial value for our customers, leading to increased spending. This year, we have observed higher marketing expenses, as we've discussed, due to the increase in new pets in the market. It makes sense for us to raise our marketing costs as long as we achieve a reasonable return on our investment. We're pleased with the returns on these investments. Additionally, you can expect to see more marketing efforts during our puppy and kitten campaign in the latter part of the year. Regarding marketing costs, we constantly assess their effectiveness. We ensure that as we invest, we receive a reasonable customer acquisition cost in return. We will continue to increase marketing costs as long as they remain effective; if they don't, we will make adjustments. Mike, would you like to address the point about free cash flow?

Michael Iddon, Group CFO

Yes. We'll just build out on that point of marketing costs, Simon. So you're pointing out, I think, the gross margin chart, where we've shown 29 basis points of investment in gross margin or investing in new customer acquisition. That relates to discounts we offer new customers. So for example, Puppy and Kitten Club members get a 10% discount on joining. 29 basis points is about GBP 2 million year-on-year. So you put that into context with the fact we double the size of the club. You can start to see how efficient actually that marketing is. And to Peter's point, clearly, that's proven a very mechanic to recruit a lot of new customers. Peter Pritchard: On the free cash flow for veterinary services? Yes, you're correct. We have consistently stated that upon reaching maturity, our practices are expected to generate a free cash flow of GBP 60 million. We maintain that forecast. To provide some context, last year our practices generated GBP 38 million. This year, we've actually seen faster maturation in our practices. With the numbers we've outlined for profitable practices, we currently have only about 40 that are operating at a loss. Remember, a practice is typically expected to operate at a loss during its first four years, and we have around 80 practices that are less than four years old. This indicates that we are ahead of the expected maturity curve. Thus, the GBP 60 million target is definitely attainable. Furthermore, in terms of growth opportunities, the free cash flow can increase even beyond maturity since practices continue to grow even after being established for over 10 years. The main point to note is that the investments needed to generate this cash flow, whether in terms of capital or operational expenditures, have mostly already been made. By effectively managing our practices as they mature, we can achieve that free cash flow. Additionally, beyond reaching GBP 60 million, there remains significant growth potential as our practices continue to develop.

Peter Pritchard, Group CEO

Simon, I think of the question you had about Slide 23. For those of you who have had a chance to look at it, this is a new chart. You like, this is a new piece of disclosure, which shows the share of customer wallet between retail and veterinary services over the lifespan of the pet. And that's based upon 4.1 million records that we've used basically, so what happens is over time, the amount of spend a customer has on veterinary actually grows. And that's not a surprise. We've always often talked about the smile of pet ownership, a big spend on retail starts and end-of-life care, you tend to see more spend into pets actually. That really starts to sort of bring that thing to life. We haven't been any more disclosure around that, Simon, except to say this is one of the real benefits we now have of really bringing our data in-house is that we're getting quite sophisticated now in looking at how we look at our customer base. So while that represents all pets, I'll share with you something we've recently done looking at dogs. So we've used our entire history within our veterinary business to look at the lifespan factually by breed within vets. And actually, there were some industry numbers that have been previously published. And actually, we now know those industry numbers are pretty much rubbish because we've been able to build that based upon every single breed by dog, and it gives us a lifespan by dog. By the way, you want a long-living dog, you get a Jack Russell. If you don't, you get a Great Dane. But what that allows us to do quite effectively is then build a lifetime value by breed. And that's really important because actually, as we start to think about our business, we know from our VIP database, the mix of breeds that we have, to allow us to know the journey of that particular breed about the things that are going to happen at certain points in their lives and allows us to do very targeted, very focused CRM. So the data itself is incredibly powerful. How you use it becomes even more powerful, and therefore I think it reinforces our confidence that we have about the growth of this market over time because we're able to see the mix of dogs that we've got, the breeds of dogs, and have a pretty good indication of how that's going to play into their lifetime value and then our business. So absolutely, our new disclosure, no more information on top of that. But I think as we move forward, I think you'll start to see how we use this to better drive the insights and activities in the business.

Simon Bowler, Analyst

Okay. Great. And one very quick follow-up just on the kind of that GBP 900 million target piece. I think when it had been GBP 600 million, you spoke to one-third of that coming from that, I know some bridges within the slides here, but is that in broad terms, still the right way to be thinking about the uplift as 2/3 retail, 1/3 to get to that GBP 900 million or has that slightly shifted?

Peter Pritchard, Group CEO

Absolutely. I definitely think that's one-third back to retail.

Operator, Operator

We will now take our next question from Matthew Garland from Deutsche Bank.

Matthew Garland, Analyst

First question, regarding the second half of the year, your implied sales number for customer opportunities in FY '22 seems to indicate a significant slowdown. Can you provide insights on the trends you're observing in the third quarter? Is there any concern related to availability, or are the challenges primarily due to demand? For my second question, can you offer a more detailed breakdown of the logistics and any additional one-off costs you are incorporating into the GBP 135 million FY '22 guidance? Should we anticipate those additional costs to be between GBP 20 million and GBP 25 million? Lastly, concerning JVP partners, I've noticed a reduction in the number of JVPs, with some transitioning to company-managed. Is there anything we should consider about this shift, especially given the strong performance in vet practices this half? How does this influence your outlook on space growth for this year and the future, and has it changed your expectations for the number of practices to open?

Peter Pritchard, Group CEO

Great. Let me take the question around how we think about sales in the second half, and I'll talk to JVPs. And then Mike, you want to talk about the cost? I think, I guess one of the realities of life is the last 18 months worth of like-for-likes have been very bumpy and bouncy, what happened is, we've had different batches playing out. So when we think about the second half of the year, I think the starting post to remind ourselves, the comps will be stronger comps than they were in the first half of the year. And therefore, the read-through to the 2-year like-for-like is probably the most helpful in terms of overall guidance. And the way that we're thinking about is whilst you'll see lighter year-on-year applies in the second half of the year, actually, when you look at the 2 years, you'll see real strength in terms of where that is. And I'll just allow you to read through. And we'll certainly be helping people read through that when we do future announcements to see how all of them has played through. So for us, that real strength is in the growth of the overall pet population that we see. So that's the same thing we talked about: 13% more new VIPs, growth in Puppy and Kitten Club. They will still result in stronger future growth, but the individual life lines will be a bit balanced as we annualize. I think the second point is on JVPs. In part, we've seen a reduction in JVP partners as we've now concluded what we call Project Light, which is where we address the challenges that we have in our vet business. And we naturally always expect to see some practices coming in and out of company ownership, but they tend to come into company ownership for a relatively small period of time until we then put them back out as JVPs. So actually, I wouldn't read anything into that at all, apart from that's just the natural ebb and flow that we see. If anything, as we move forward, we now have greater confidence, we're talking about restarting and reopening our vet pipeline in terms of new practices. And we've already opened 3 new projects in the last 3 months being Handforth, Guildford and Brighton. And what's very interesting is we always measure the amount of potential JVPs coming towards us for our future pipeline. And actually, this year, that pipeline has continued to strengthen. And in part, we put that down to the success that we're seeing in our business, the success does breed success. But also our competitors will really be the same choice, which is being in a corporatized model. And of course, the real attraction for most JVPs is to have total freedom of clinical independence as well as being able to be better rewarded for their hard work and that's driving more vet candidates than ever before. So you'll see in our future guidance, we're talking about reopening that space. And our plan for most of those is to open them as JVP practices. But we're required and where necessary, we will open company-owned, but we often see them in the short-term measures before we move them back into JVP hands. So Mike, if I hand you over to talk about availability and logistics costs?

Michael Iddon, Group CFO

Yes, of course. And just to context, Peter's point on sales, Matt. First half last year, our comp was just over 5%. Second half last year, our comp was over 12%. So a real step up in terms of the comparable number that we're going to lap in the second half. So yes, headline like-for-like will be lower in the second half, but emphasize enough to point around looking at do like-for-like is a better indication of the progress we're making. So your question on costs, yes, you're about right actually with those numbers. So freight full year, around about GBP 12 million year-on-year increase. So which we've taken half of it in the numbers we're talking to this morning. In terms of COVID cost, we actually at the start of the year planned around GBP 9 million for our COVID costs. And that's a number we talked externally about. Actually, COVID costs are proving to be better than that. So compared that to mine, we're probably planning for the full year on around GBP 5 million. So we've probably seen a saving in the first half of about GBP 2 million compared to where we were planning COVID costs, and we expect that it was no changes in the external environment around COVID to be about the same. Yes. So GBP 5 million for COVID costs one-off year-on-year, GBP 12 million for freight. So in total, we're looking at around GBP 17 million of costs.

Operator, Operator

We will now take a follow-up question from Simon Bowler from Numis.

Simon Bowler, Analyst

I mean just a quick one, a follow-up on that kind of freight wind, which is, as you say, is a reasonably big number and not something at this stage you're expecting to change. I understand that your kind of retail pricing is set very separately to that, but presumably, if that was to become a more permanent fixture and at least part of that is to become a more permanent fixture? Is that something that you would expect to ultimately be able to pass on in pricing? Or do you think they are best considered as entirely separate?

Michael Iddon, Group CFO

Inevitably, Simon, we're suffering from those freight costs in the part of the industry and how we're managing, there will be price increases for those products that have brought over from overseas. Because that's just the sustained increase in the cost of acquisition of those products. But it wouldn't be the expense being uncompetitive in the marketplace. But clearly, those growth rates are well publicized. It's not just us who have been impacted by those. But we had to stay, we'd have to think very carefully about the pricing. And the sourcing actually of the products that we're bringing in from overseas.

Peter Pritchard, Group CEO

Yes. I think the sad start, actually, we don't just look at product cost based on that, we actually look at all the costs that are in our business. So when we think about because not to resell, we think about rent. And actually, whilst we've got some inflation in freight lines, we actually have material reductions in others. So we always try and balance those off. And our price position has been really solid over the last 2 years. And I think we do have a real opportunity around driving operational leverage around our business and throwing back at that balance right. I think what Mike really alludes to is we're getting this balance to customers, balance to shareholders, balance for us, and navigating our way through thinking through the medium term of how we continue to grow our share of wallet with customers. I think just for anybody else's benefit, 80% of this actually is domestically-sourced. So our exposure to freight is not quite the same sort of level of loss. And we're not a very seasonal business. So we pretty much bring the product into our business every month. And therefore, we're not at the sort of stabilize exposure in the business may well be.

Simon Bowler, Analyst

I think this connects to the second part of my first question, which is that while you don't provide specific details, it seems reasonable to assume that freight costs and their effect on your product gross margin are primarily linked to the accessories segment of your business, while food gross margins have remained more stable due to the different sourcing for these two categories.

Peter Pritchard, Group CEO

You got it in mind, we have before the accessories, food is pretty much all near-sourced.

Operator, Operator

There are presently no further questions. I would like to turn the conference back to Mr. Pritchard for any additional or closing remarks.

Peter Pritchard, Group CEO

Great. Thank you, Tracy. And thank you for your questions and participation. It's always great to get these great questions. So I appreciate that. Let me be the very first to wish you and of course your pets a very Merry Christmas. And we'll speak to you hopefully in the coming weeks around our roadshow. Have a good day, everybody. Thank you.