Pets At Home seems to be a great business, but how much has been left in the fuel tank by its private equity owners?

Pets At Home seems to be a great business, but how much has been left in the fuel tank by its private equity owners?

Pets At Home is not the only private equity owned business to find that the door to the IPO market is now wide open, thanks to the recent re-rating of the general retail sector coinciding with the much-vaunted pre-election economic recovery. But the Pets At Home IPO announced yesterday will be seen as a key test of investor appetite for private equity owned retailers, as it has been through a couple of owners in the last 10 years, so it has been owned quite a long time by private equity.

At first sight, there appears to be a lot to like about Pets At Home. The business is highly profitable and cash generative and has a good customer service culture. And given the number of cats and dogs that the nation owns this is a big market. And yet…some questions arise.

One question is that if this is such a great market to be in, how come Pets At Home has no big competitors? Of course, the big supermarket chains are formidable competitors in the pet food market, but it is odd that there are no other big specialist chains. But the main answer to this is that Pets At Home bought its main UK competitor Petsmart from its US parent at the end of 1999. And selling live animals isn’t everyone’s cup of tea, as it were, given the technical and operating challenges, which is why much of this fragmented market is controlled by local independents.

Another question is that if this is such a great market to be in, how come Pets At Home isn’t growing faster than it is? The growth trend in both sales and EBITDA since KKR took it over in early 2010 is about 10% a year, which is obviously not bad, but isn’t that exciting. Is it really true that money is no object when it comes to spending on pets? There may well be some pressure on such a discretionary area of consumer spending, but the main problem is simply that Pets at Home has already improved its profits and profitability a long way.

When the private equity business Bridgepoint bought Pets At Home back in 2004 from its founder (despite fears that Anthony Preston was selling out at the top!), the business wasn’t making much more than £20m in EBITDA off sales of £200m or so and the gross margin was only around 40%. But the young new CEO Matt Davies set to work and now the gross margin is over 50% and the company has an EBITDA forecast of not less than £110m for y/e March (on sales of £660m or so).

But Pets At Home still has plenty of room to open more stores and offer more services, so it would be wrong to overdo the caution. There’s nothing wrong with being a pretty stable and predictable business and, although KKR are leaving Pets At Home with quite a lot of debt, the business is so cash generative that it will be paying a decent dividend and income funds should find a home for some shares.

Some City institutions grumble about private-equity backed businesses being foisted on them, starved of investment and with costs cut to the bone, but KKR has invested in Pets At Home, in terms of building new distribution warehouses and systems, so there shouldn’t be a problem in this sense.

And the stockmarket will have an obvious benchmark for Pets At Home in the valuation of the leading US pet care retailer PetsMart, which has a $6.7bn market cap, albeit its share price has been pretty sluggish in the last couple of years.

The quoted UK retail sector needs some fresh new blood to replace its tired old stalwarts and all the companies which have gone bust or gone private in recent years (from HMV, Clintons and Game to Matalan, Boots and Peacocks), so KKR will be hoping that investors don’t look this gift-horse in the mouth for too long and that customers find that Pets At Home has plenty left in its fish tank!