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Recently, I added FTSE 250 share Pets at Home (LSE: PETS) to my portfolio for the first time.
At 6.6%, the dividend yield certainly attracted me. But my main hope is that the Pets at Home share price will grow, having declined by 51% over the past five years.
In the stock market, what goes down does not necessarily have to come up again. Meanwhile, no dividend is ever guaranteed to last – and Pets at Home’s interim dividend for the current financial year was flat.
So, could this be a long-term FTSE 250 recovery play? Or might it turn out to be a value trap?
Obviously I am hoping for the former, but any serious investor always tries to look at both the good and the bad in an investment case.
Retail marketplace is challenging
There is no shortage of evidence that the UK retail sector faces a tough operating environment. That includes Pets at Home.
While the market for pet food, equipment, and the like may be fairly resilient, it is not rock solid. In a weak economy, some people will feel less inclined to take on the extra costs of having a furry friend.
Still, the market is large and Pets at Home is well-established, with a sizeable customer base.
The first half of the current financial year saw the company’s retail revenues decline 2% year on year, which is not good. But they still came in at £680m, underlining the company’s economies of scale and sizeable existing business. I think that could form a strong foundation for recovery.
Vet business is growing
While its shops may be better known, there is another part to Pets at Home’s business: vet services.
This is in growth mode, with revenues up 7% in the first half to £376m. This is a growing, profitable business with pricing power. After all, pet owners want to take care of their animals and will typically pay the price to do so when they need to, even through gritted teeth.
Over the long term, I see ongoing potential for Pets at Home to keep growing the lucrative vet services business. That could help grow the FTSE 250 company’s earnings and hopefully with it the share price.
Can Pets at Home recover?
Still, as the tumbling share price suggests, all has not been well for the business.
The company has said it believes the root cause of its recent sales challenges is product-related. If it can revamp its product offering to give customers and potential customers what they want at a price they find acceptable, I am optimistic the retail business can recover. But there is a risk that the company could make further bad choices about its product offering in future, hurting revenues.
Another risk is rising staffing costs. Pets at Home reckons it has taken a £48m rise in National Insurance contributions and National Living Wage rises over the past three years. If additional costs keep mounting up, that is a risk to profitability.
Why I’ve invested
But despite the challenges facing the FTSE 250 firm, I still like the fundamentals.
The end market is large and fairly robust. The company has a large customer base and loyalty scheme, it has a good network of shops and the vet practice division is in growth mode.
