Pets at Home Group Plc (PETS) Earnings Call Transcript & Summary

Mike and I will now take your questions.

Thanks. And just before we move to Q&A, if I could just ask if we can start with one question from everyone, and if we've got plenty of time on the call, we'll come back around again in case there are anymore.

[Operator Instructions] First, we have Kane Slutzkin from Deutsche Numis.

Just quickly just on the guide. I'm just sort of thinking about particularly on the retail side, the sort of exit rate in Q2 of about -- I think it was about 1%. Just wondering in your guide, are you sort of -- is this sort of -- could it get worse? Or do you feel that's it and hence, you're kind of derisking the FY '25 number? I don't know if you want to use kitchen thinking as a phrase, but would that be sort of fair to say that there's a sort of element of derisking to that number that the 1% kind of it doesn't get worse than that?

Yes. Thanks for the question. As you say, this guide is really about the retail business performance. Our vet performance is really strong and driven by the underlying strength of our vets model, the joint venture model. So we don't anticipate any change to that through the back half of the year. The retail performance, as you say, is really about subdued consumer market. And what we factored into our guidance for the remainder of the year is really no improvement in that consumer market. The trends that we see around normalization, inflation are also, we don't expect any change for the rest of this fiscal year. As we move into next year, we expect normalization and inflation pressure to unwind a little bit. But the guidance for the back half of this year is no real change in the environment. Michael, I don't know if you have anything to add.

Yes, I think that's a very fair comment to make. Two things I'd add though, Kane, to Lyssa's comments is that in our retail business, of course, we've got a really good grip on the costs. You'll have noticed in the first half, actually costs are lower year-on-year, and we'll continue to do that in the second half of the year and gross margin is remaining pretty stable and even with a really strong price position. So the basics of our retail business have really never been in better shape in terms of availability, the new DC, price position, operational standards. But it's the market that's subdued. And we don't expect that market to pick up really until the spring of next year. And that's what's built into -- in our forward-looking guidance now for the balance of the year.

And our next question now comes from Jonathan Pritchard from Peel Hunt.

A question on costs, on wage inflation. You called out a number of, what is it, GBP 18 million as a gross number. Just cast your mind back to before the budget. What was your expectation for wage inflation or the absolute number that you'd be facing? And how much of the sort of incremental do you think you can mitigate?

Yes. Thanks for the question, Jonathan. So if we cast our minds back slightly further to last year, we also had an GBP 18 million wage inflation hit based on that national living wage increasing. And as Mike said, we've been able to hold our costs flat in this half, showing that we were able to mitigate that. That was about half of that was unexpected, and we've been able to mitigate. Obviously, another GBP 18 million hit on top of that is more again. But we've got a proven track record in productivity, in our initiatives to absorb some of that. And actually, we've still got all of the automation in the distribution center, the growth in our digital platform ahead of us. Having said that, we'll look at all the levers. We'll look at how much we can ameliorate through productivity, through efficiency, how much we may have to pass on in pricing, how much we may have to take to the bottom line. And that's an exercise that we are in the middle of at the moment. This is fairly new news. We're working through our business planning cycle, and we'll come back with more detail on that in the spring. Mike, do you have anything to add to that?

Yes. So that GBP 18 million, Jonathan, you're talking about next year, the -- what came out of the budget. So that's National Living Wage and it's the increase in national insurance contribution. So that GBP 18 million splits GBP 8 million for the 6% increase in national living wage and GBP 10 million for the increase in national insurance contribution. So in our planning, we would have built in the national living wage. That is around about 6%, and that's what we built into the planning. The new cost that is -- and Lyssa has been talking about it just then, is the GBP 10 million of additional national insurance contributions that like all big employers, we're going to have to face into how to deal with. And Lyssa is quite right. We've got a really strong track record of dealing with these cost headwinds. Our rent program has been incredibly successful. We're very focused on procurement of things like goods and services. We simplified the business a lot. We've taken 160 roles out of the head office, for example. And as Lyssa has just said, we've got all the automation still to come as we complete our network optimization in the second half of this year. So we've got those levers. But we do need to look at this carefully. We're going to go into our detailed business planning process straight after Christmas. We'll complete that by the end of March, and we'll be able to give you a better update when we speak again at full year results in May.

From Jefferies, we now have Andrew Wade with our next question.

I'll just ask one as requested. How much of sort of additional cost offset have you had to counter the revenue sort of shortfall in the year? And just one area I'm interested in is particularly around marketing spend where you talked about increasing that this year. So sort of essentially, one, how much have you found additional cost saves that you've already implemented during the year? And what -- how big is that, particularly how much has come out of marketing?

Yes. Mike will take that one.

Yes. Good question, Andy. Yes, we did start the year, remember, with the plan to increase our marketing by GBP 12 million and as we gone through the year, the right thing to have done is actually look to that marketing cost. And we have used the saving there to help offset, obviously, a lower sales than we expect as we go into the second half of the year. So our year-on-year marketing cost increase, which was GBP 12 million in the original plan will be around 4 or 5 now.

Right. Got you. And other cost offsets that you found during the period?

Well, we continue, as I say, on our program of managing costs through. So overall, GBP 305 million of costs in the first half is actually lower year-on-year by about 3%. So we're pretty pleased with that. But it just shows the focus we've got. And the other one that will be new, though, I mean I know we talk always about the rent program fueling, is the reduction in our support office, which is never a decision anybody takes lightly, but we have removed 160 roles out of our support office. Now this year, we'll get a part year effect of that. Next year, the full year benefit is about GBP 10 million. So pretty material. And of course, that's helped us manage through the impact of the lower sales.

And up next, we take a question from Manjari Dhar from RBC.

I'll just stick to one as well as requested. I just was wondering on the historical market growth trend number of 4% per annum. I wonder if you could remind me, does that include the COVID boom we saw in the pet population? And if so, is the number different excluding that? And I know you talked -- sort of related to that, I know you talked to a relatively rapid bounce back from periods of slower growth. When are you expecting or do you have a sort of a time line in mind to get back to that 4% level?

Thanks for the question. So 4% has been a very long-run average actually over the decades. It does include the COVID boom, although that was probably a bit higher than 4%. So it's been something that's been structural in the market for quite some time. And that's been driven by 3 real growth levers. The first is premiumization. We've talked about that a lot, customers seeking out higher-end goods and services for their beloved family member, humanization, which particularly shows up in the vet business, not only, but particularly there where advances in human health care are coming across into veterinary medicine, and we've seen that as a continued driver in the veterinary business. And then the third was penetration, which is we had this huge boom through COVID, and we're now stabilizing. So we're still signing up 15,000 puppies and kittens a week. We still got really good strong growth as the replacement rate continues, but we're no longer seeing absolute growth, the penetration stabilized at a higher level. So when you look at those 3 trends, they're still there, but there's 3 elements that are features of the market right now that probably are running slightly in a different direction. So the first would be normalization. So we're lapping a year of continued growth with a year of stabilization. Next year, as we move into the spring, we'll be lapping a year of stabilization we expect. So nothing has really changed in our expectation of those normalization trends, we expect them to phase out through this year. The second is inflation, which was obviously very high over the last couple of years and is currently running at about 0. Long run, it tends to run at 1% to 2%, and we expect that to phase back in as well through the coming year. The third, though, is this very, very weak consumer, which is probably running counter to some of the premiumization trends. And that's something that's harder to predict and is a real feature of the market right now. So we've got these 3 short-term features that are offsetting those long-run structural trends, which are still there, but not enough to offset where we are now in terms of those other 3. I would say, though, that our consumer growth is really strong. We now have 8.1 million. We've broken through the 8 million barrier, 8.1 million customers, active customers in our Pet Club. That's more than half the pet owners in the U.K. and about 1/3 of those pets are younger than 3 years old. So the growth and our strategy was designed always to do this, unlock share of wallet, deepen our relationships with those customers, use our data, use omnichannel use, integrated use, consumer centricity to deepen those relationships, and drive out that value over the short, medium and long term. And we can see that, that strategy is working as we continue to outperform the market across both of our businesses. So we've got real confidence that when the market does return to 4% growth, which may not be fully in the spring, but we expect to see some of that unwind in the spring, that we are very well set to take advantage of that growth.

We now have a follow-up question from Kane Slutzkin from Deutsche Numis.

Sorry, just a quick one on the accessory piece. Could you sort of just give us a feel for how that's looking, particularly on the core piece? I understand that's obviously slowed down, but just any sort of thoughts on sort of breakdown within the accessory piece, I guess, between commodity and core.

Yes. So thanks, Kane. Yes, accessories is a key part of our business and obviously a category that has lagged behind over the last couple of years versus our food growth. And as we look over the half, actually, there's not a lot to choose between categories, accessories, food, consumables, which is the sort of nondiscretionary part of accessories, puppy pads, food bags, cat litter, those kind of things are all pretty similar in terms of their like-for-like. So I think we're approaching the point of stabilization in accessories. But clearly, stabilization is not our aspiration. We need to return that category to growth. We know how to do it. We've got examples in our Christmas range. Our Christmas range is up year-on-year. Our sell-through is really strong. So we know when we get our range architecture, our merchandising, our price positioning, the innovation right, we can drive that category, and we're currently undertaking a subcategory by subcategory review all through our discretionary accessories to take those learnings and look at the architecture to get us back to growth. It's also worth noting that our digital penetration, our participation of accessories is only 10%. So only 10% of what we sell through our website is in the accessories category, and our new digital platform through the journeys, through the user experience, we're using our data for cross-sell and upsell in a targeted way, doing things like add to plan, add to order for our subscription sales for our Easy Repeat are all areas in which we can really drive our accessories categories. So we'll be looking at our accessories categories and their architecture with an eye on how do we unleash digital growth as well. So I think it's an opportunity from here. We're seeing signs of stabilization, and when we can get that going again, there's really sizable profit growth because the margins in that category are really strong. Mike, did you have anything to add?

It's a really complete answer. I'd just emphasize the point around our digital platform. Actually, our share of accessories on there is really low. It's only around 10% of our sales historically, and that digital platform will give us a great opportunity through those relationships we can now build with our customers to actually sell more accessories online, and we actually see, to Lyssa's point, that being an opportunity for us going forward.

And we take another follow-up question from Andrew Wade of Jefferies.

I just sort of wanted to touch on the -- as you've just been talking about digital platform there, good opportunity to ask about that. What sort of early signs are you seeing that are going to sort of support growth, justify the investments we've made in those platforms and sort of really drive that cross-selling and the accessory side of things?

Yes. Thanks, Andrew. So we now have a market-leading digital platform. And that's really important. It's a core plank of our strategy to provide an integrated omnichannel consumer-centric experience, and it's also where a lot of the growth in the market is going to come in the coming years. So early signs are positive. Our app sales, and that's important because when customers are in the app, it's a much more engaging and kind of core part of our ecosystem versus the web. App sales have doubled since we've relaunched and our Easy Repeat subscription sales, and you'll recall that one of the things we are trying to do with our new platform is drive more subscriptions. Easy repeat subscription sales are up 20%, both because the user experience is better and because we have got more than double the number of SKUs now available on Easy Repeat, which is another benefit of the platform. So early signs are positive, but there's a lot more to come. The web experience, which is where we had some transitionary effects is improving and traffic is improving as we add functionality and build our efficiency there. We've got a lot more to do, a lot more opportunity in user experience and features, particularly around subscriptions and Easy Repeat. We've got a huge opportunity to leverage our first-party data, the 10 years of data on 10 million pets in the ecosystem. Currently, we're using it to personalize our product recommendations, which is showing really good signs, but we've got opportunity to do that right across our digital experience. We haven't yet built advice, expertise, that wonderful experience when you get into a store and you talk to a colleague, that's something we can bring to life online. And related to the previous question, our ability to cross-sell and upsell using our data and taking advantage of our highly automated distribution network now with e-commerce and Stafford is really significant. So we're confident that we have a best-in-class platform. We've got some early positive signs, but actually, the opportunity and the benefits really are all ahead.

Very clear. And while I'm on, in terms of your -- I think it sounds like you outperformed the market by about 1% on the retail side of things. I think you talked to the market being down about 1% and you were sort of flattish on a like-for-like basis. I guess if you're looking at -- I know obviously, the vet was a long way ahead of the market, which got you to the outperformance that we're looking for longer term or medium term versus the market. But do you think that 1 percentage point-ish outperformance versus the market in the retail side of things is sufficient to sustain your medium-term growth assumption? And/or do you think you can accelerate those market share -- that market share gain?

Yes. So great question. So the 1% is not -- obviously, the vets is doing really strongly in several percentage points of outperformance, 13% growth in a market that is a few single digits positive. The retail outperformance is not what we would target over the medium term. We would want to do more than that. And I think that's where the benefits of the 2 material investments that we've made in our distribution center and in particularly in our digital platform will start to unlock that growth in the coming years. All of those things I talked about in digital, that's where a lot of the market growth is coming, but also leveraging our digital experience into stores. So 30% or 40% of what we sell online is actually collected in stores. We know customers want an omnichannel experience. We continue to invest in our store network. We've just launched 3 of our concept stores in Kettering, in Hull Anlaby and in Brentford and we've got one launching on Friday, our flagship in New Malden, and that's bringing interactivity and showcasing key categories like nutrition and well-being. So there's a lot of opportunity, I think, throughout our retail business, and with 8 million -- more than 8 million customers in our Pets Club and the lifetime value, our strategy is to drive more significant outperformance than we showed this half.

And just to add to those comments, Andy, obviously, looking back is a really good way to give you confidence looking forward. And if you look back, of course, we've taken more than our share of the growth in the market. So when the market gets to grow back at 4%, if you look back over time, we've actually grown around 9%. I mean you went back to 2017, our market share was around 18%. Today, as we came into this financial year, it was about 23%, 24%. So we've always taken more than our share of the market growth. That's clearly a different dynamic than when the market is in decline. When to grow, you've got to take share of somebody else. So our financial framework that says when the market grows at 4%, we grow at 7% is still very much intact. And of course, when we grow at 7%, the operational leverage, which we know exists in the Vet Group, fixed cost base, fee-based income and in our retail business helps the profits grow faster than the sales. So we are looking forward to getting back to 4%. We'll grow at 7% and then that financial framework enables us to grow at 10%, and that's still very much intact.

And we now move to a question from Paul Rossington from HSBC.

On the competition piece that you just referenced and share gains, I know it's a relatively small level of outperformance, but do you know from whom you are taking that share currently? And have you seen any meaningful change in the competitive environment against that backdrop of lower market growth? And that's my question.

Thanks, Paul. I mean our competitive set is very broad actually, and we're the only provider that competes across the entire pet care market with leading market shares. In vets, I think with -- our outperformance is so significant. We'll be taking a bit from everyone. We are opening practices. We opened 2 new practices in the half. We've got more to come. Our pipeline is fuller than ever. We're signing up 18,000 new pets a week, and we've got 8% more clinical talent. So in both the market for talent and the market for consumers, we're winning. Other vet operators are closing practices. We're still opening and we're still growing very, very well. So I think in that case, we are just taking share across the board locally as consumers really love the fact they've got a local vet, a known vet, an owner-operator invested in their community and those are the sort of practices that clinical talent wants to work for. So there, we're winning across the board. In retail, I think, again, we have a very broad competitive set. It will be everything from the grocers through to the specialists, Jollyes Pet Corner through to online specialists like C-Pets through to online generalists like Amazon. And against that backdrop, again, we've historically taken a bit from everybody, and we can map shares month-on-month. It's quite a hard market relative to grocery to get a really good read on. There's new players in there, specialist DTC like Butternut Box, we've done a deal with actually in retail. So it will be a bit from everybody. And I think the important thing is that our customers, those 8.1 million pet club owners, they are only spending on average 30% to 40% of their share of wallet with us. So we don't have to go and win new customers. We just have to persuade them to spend one more of their shops a year with us, do one more groom with us, buy their flea tick and worm from us, buy accessories from us, upgrade to Advanced Nutrition. These are all things that our strategy is designed to do and to optimize. So it's that share of wallet opportunity that will actually drive our outperformance and our share gain rather than having to win new customers. And I think that's what's embedded in our future and in our opportunity.

Okay. And while I'm on the line, could I have one follow-up, which is, could I ask about own label performance within food during the period?

Yes. Own label is one of our standout key competitive advantages. And our 2 premium own labels, the Advanced Nutrition are AVA, which competes against Royal Canin and Wainwright's, which goes up against James Wellbeloved. Those products would generally be 10% to 20% cheaper than the branded equivalents and better quality. And we've seen this half yet again that those Advanced Nutrition own brands, own labels outcompeted the branded products and are now bigger than their branded equivalent. So one of the opportunities we have ahead is to take that own label in food to more elements of the market. So we recently launched nutribalance in the half, which is a kind of a mid-tier science brand. But as we map out the space, we map out our own brand, we think we've got more opportunity in cat as well as in dog and all tiers of the market to really drive home that own brand opportunity. And that's an area where deals like the long-term deal we have with Cranswick really help us because we can drive innovation at the top end and good cost throughout the range. So lots of opportunity there, and it's a really core part of our strategy.

Yes. Just a couple of add-ons to that, Paul. own label participation actually ticked up in the half to just over 30%, and that's across both food and accessories actually. And just building on that point I made earlier around our digital platform giving is an opportunity on accessories because accessories participation has always been quite low. Actually, the same is true for own label. Our own label participation online, those customers obviously search for brands. It gives us a great opportunity there as well to increase our own label online participation. And as we know, that gives us stronger margins as well and makes those customers stickier. So we're really encouraged by what we've seen with the progress in own label in the first half and the opportunities, by the way, still to come.

We do have another follow-up question from Manjari Dhar of RBC.

I just had a follow-up on the vet group. I wondered if you could give some color on how much of the sales growth you're seeing is coming through practice extensions versus maturity in the portfolio and new customer growth? And how much runway do you see for further extensions now? Is there a point where you'll reach a limit?

Yes. Good question. You're quite right, Manjari. We've got some proven growth levers in our vet business, not just driving out the maturity, opening new practices and of course, the extension program. The majority of our growth though is still coming through driving out the maturity. When you build an extension, it takes a while to generate the revenues to bring that back. But we would expect every extension we build to add 10% on to at least 10% of the revenues of the practice we build it on. Last year, we built 26 extensions. If we look forward, we have a plan to build over 100 over the next few years and a plan to continue to open new practices, opened 2 so far this year and getting back on opening new practices is a key component of those growth levers. So those growth levers really well proven. But in our first half, it was the maturity of our existing practices. So we're sort of seeing average revenues now on an annualized basis move up towards about GBP 1.3 million. And we know the operational leverage on that is really, really strong and gives us a real, real financial edge there. And I think we're seeing that coming through in the profits as well because the cost of providing the services to those practices is relatively fixed on an expanding revenue base.

And as there are currently no further questions in the queue, I would now like to hand the call back over to Ms. McGowan for any additional or closing remarks.

Thank you, everyone, for your time today.