Just under two weeks ago, I wrote an article on 'Why the market has Greencross wrong'.
In it I wrote that the market was apparently treating Greencross Limited (ASX: GXL) like a 'roll-up' business like G8 Education Ltd (ASX: GEM) or Slater & Gordon Limited (ASX: SGH) despite the fact that it was capable of legitimate growth organically as well as by acquisition.
As a result, I concluded that a price of $5.15 and a Price to Earnings (P/E) equation of 15 for a 40% increase in earnings this year was great value. The deeper I dug, the more compelling the 'Buy' case looked and I ended up buying shares at $5.21 apiece.
Greencross shares now make up just over 6% of my total portfolio.
Why did I buy Greencross?
First, growth potential and loads of it. Second, it operates in a growing industry (offering macroeconomic tailwinds) unlike many other retailers. Third, it is a relatively small player which leaves plenty of room for expansion by acquisition, and four, company figures show there are several compelling opportunities to increase the average spend of customers, netting more profit for Greencross.
Growth by acquisition
Research commissioned by Greencross shows that the ~$8.7 billion pet industry in Australia is growing by approximately 4% per annum, hitting $11 billion in 2020. Greencross currently controls only 8% of this sector, with a target of 20% over the medium term.
Approximately 59% of Australian households are within reach of a Greencross store, but only 5% are within easy access of all three Greencross 'propositions' – vet, retail and grooming services. Customers that use all three services spend 5x as much as those that shop in a retail store and 2.2x as much as those that use a Greencross vet.
This means there is actually a compelling financial reason to co-locate Greencross stores and buy or establish more stores in more locations.
Organic growth potential
In addition to growing its footprint in terms of store numbers and market share, Greencross is also achieving 'like-for-like' (LFL, or 'same store') sales growth of 6% per annum for both its vet and retail businesses.
This growth is substantially higher than that achieved by most other Australian retailers and to my mind indicates that Greencross is not as vulnerable to consumer sentiment and discretionary income as some.
Greencross also has a variety of other sound initiatives to generate growth, including own-brand vet products and a variety of pet services including insurance, burial/cremation, training and boarding, all backed up by an online offering.
As I wrote in my earlier article, Greencross has achieved just over one third of its growth from acquisitions in recent years. More importantly, Greencross' underlying Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA) has grown substantially faster than revenue over the past few years, meaning that the company actually appears to be generating benefits from its scale in terms of synergies and cost savings.
This further differentiates it from pure 'roll-up' businesses.
Risks and when I'd sell
Greencross carries $260 million in debt (from a $350m facility) and the company will be increasing its debt by $50m this year in order to fund growth. While management states that growth will self-fund from the 2017 financial year onwards, my investing thesis relies on debt plateauing and gradually decreasing from then.
Dilutive rights issues are right up beside persistent high debt as one of my warning signs. While I'm not averse to another capital raising if the right opportunity presents itself, I would vastly prefer that they be avoided entirely.
Further, Greencross hasn't generated any Free Cash Flow in recent years. While I am willing to accept this as long as debt remains in check and stores perform as expected, I count on the company achieving positive free cash flow from 2017 onwards and failure to achieve this will be the catalyst for a rethink of my investment.
Finally, I am counting on the pet industry continuing to grow roughly at 4% per annum as forecast and sales being fairly resistant to changes in discretionary income. Should it become apparent that rising unemployment and weak sentiment is having a sustained impact on Greencross (particularly as I expect economic conditions in Australia to deteriorate over the medium term), I may have to rethink my investment.
With all that said, Greencross has achieved a Compound Annual Growth Rate of 25% per annum for its EBITDA since 2011 and high growth looks likely to continue going forwards. Despite the above risks, at prices under $6 Greencross looks to be fantastic value and a solid long-term investment opportunity.
