I've had my eye on Greencross Limited (ASX: GXL) for quite a while, but the company really came to my attention in January after it dipped below $8 for the first time since 2013.
A subsequent earnings downgrade on May 8 compounded the losses, and Greencross shares now change hands for just $5.15 – their lowest point all year and a loss of 44% in the past 12 months.
Curiously the 'downgrade' still represents a 40% increase in earnings per share compared to the previous year.
One of the biggest factors that seems to be playing into Greencross' slump – and it has nothing to do with its performance – is the market's perception of it as a 'roll-up' business similar to G8 Education Ltd (ASX: GEM) and Slater & Gordon Limited (ASX: SGH).
'Roll-up' or 'arbitrage' businesses acquire privately owned businesses at 4-5x their earnings before tax and fund the purchase by issuing new shares to shareholders at a higher multiple (12 or above).
While Greencross does conduct this kind of acquisition, it is starkly different from Slater & Gordon or G8 because it can generate growth organically as well as growing by acquisition.
In addition to positive long-term tailwinds for the sector, Greencross offers fantastic growth potential, reasonably defensive earnings and looks like a bargain at today's prices. Here's why:
- Plenty of room for organic growth (i.e., without acquisitions)
Greencross controls an estimated 8% of the ~$8.7 billion pet industry, a market which is forecast to grow at 4% per annum, hitting $11 billion in 2020. With a combination of increased customer loyalty, cross-selling opportunities and more stores, Greencross aims to control 20% of this industry over the medium term.
Currently, Greencross services are within reach of 59% of Australian households, however only 5% of households are within easy access of all 3 Greencross 'propositions' (retail, vet, and grooming services).
Furthermore, customers that use all Greencross services (see picture) spend 5x as much as those that only shop in a retail store, and 2.2x as much as those that use a Greencross vet. This means there are plenty of opportunities to cross-sell products and co-locate stores.
- NOT a roll-up business
Being able to achieve like-for-like sales growth goes a long way towards separating Greencross from 'roll-up' companies which only grow through acquisition. Greencross' two business lines, retail (75% of revenue) and veterinary (25% of revenue) are both achieving like-for-like sales growth of 6% at present.
Over the past three years, Greencross' retail arm has achieved just over one-third of its revenue growth from acquisitions, with the rest coming from organic growth within existing stores:
A key point to take away from the above graph is that 'Underlying EBITDA' (Earnings Before Interest, Tax, Depreciation, and Amortisation) is generally growing faster than revenue, which indicates both that costs are under control and that the company is achieving synergies/ benefits of scale.
Importantly, planned future acquisitions of clinics and retail stores (20 each per year) and 'co-locations' (12 per year) look highly likely to continue this trend thanks to cross-selling opportunities and other initiatives like increased penetration of Greencross' private-label vet products.
- NOT a roll-up business – Part 2
While debt will increase in the near term in order to make new acquisitions, management has announced that its growth plans will become self-funding in the 2017-2018 financial year, and the company's total leverage should gradually decline over time.
Greencross has $90m undrawn cash remaining from a $350m debt facility, and with $50m forecast to be spent on acquisitions this year it looks as though there will be sufficient left over to fund purchases until the acquisitions become self-funding.
This means no (or few) dilutive share issues and hopefully management will work on paying down the mountain of debt before it begins to wobble under rising interest rates (which fortunately look to be some way off).
Despite these risks, Greencross looks very appealing at today's prices. The company trades on a Price to Earnings (P/E) multiple of 16 – same as the banks! – with much higher growth potential.
My two biggest concerns are the company's lack of free cash flow over the past two years and its growing debt burden. Investors will want to watch that these two metrics improve over the next few years – especially as the company begins to self-fund its expansion in 2017-2018, but for the moment the company's focus on expansion appears justified:
Greencross has delivered a Compound Annual Growth Rate (CAGR) for its Earnings Before Interest, Tax, Depreciation, and Amortisation (EBITDA) of 25% per annum since 2011.
Importantly, this rate of growth looks likely to continue for the foreseeable future and I believe that today's prices represent an excellent time to buy into Greencross Limited.
