Vets are under fire – is it time to sell your shares, or buy more?
What to do when a regulatory inquiry targets an industry sector: should you buy shares that react badly, wait for things to settle – or even sell?
Such a tactical challenge is in focus after the Competition & Markets Authority (CMA) launched a formal investigation earlier this month into the veterinary sector, a £2bn industry. A review initiated last September now cites “multiple concerns”, as if baring teeth.
Shares in Aim-quoted CVS Group – the purest play on vets – initially plunged 25pc to about £11, rebounded to £11.50 then fell below £10.50. The “buy the drop” strategy has yet to work. The group said it has “engaged constructively” with the CMA and put forward solutions that could be adopted industrywide.
Retailer Pets at Home Group (with a vets side) dropped 9pc then rebounded such that the share price is roughly unmoved.
CVS’s rebound made me feel as if I was missing out, then the drop affirmed my wariness. Market moves so easily dictate one’s sentiment but it is vital to think matters through.
It marks a second big drop for CVS which fell from £21 last September to £15 on news of the CMA review, then crept up (falsely). If expectations for £68m net profit this financial year to June are fair, the earnings multiple is a modest 11 times, albeit it offers a scant yield given cash generated is used for acquisitions.
If the CMA decides the industry has become too concentrated, such a business model is exposed – at least in the UK, although CVS is branching out in Australia. Private vets’ practices have been enticed to sell out to corporate groups, which owned 10pc of the UK industry in 2013. Today, six of them control nearly 60pc.
It took the CMA over two years to investigate JD Sports’ acquisition of Footasylum then demand the business be sold. Apparently, this vets inquiry will take 18 months, an uncertainty shares will have to bear.
CVS has seen volatility before. Its share price today equates with late 2017, it then fell to 450p by early 2019. Costs had surged for temporary “locum” vets and nurses partly to replace those returned to continental Europe after Brexit. Pay also rose generally.
Pets at Home may have a lower risk/reward profile
The group is chiefly known for pet products sold in stores or online, yet its last results showed 58pc of its profit came from vet services, 42pc retail.
It’s not hard to see why the CMA investigation was launched when you find out that vets business has a 42pc profit margin versus 3.4pc for retail. The watchdog alleges that maybe a quarter of large vet groups’ revenues derive from medicines that consumers could get cheaper elsewhere.
Pets’ multiple of expected earnings is now similar to CVS but being cash-generative means it offers a 5pc yield covered about 1.6 times by earnings, or more like three times by cash generated after investment and other needs – so-called “free” cash flow.
It is easy to get lured by yields but they are small in the context of overall shareholder return. Pets’ long-term share price chart is a roller-coaster – timing is important.
Pets At Home said it was “incredibly disappointed” by the CMA’s decision, and argued that its model “promotes competition in the market and helps to keep prices low”.
Has growth in pet insurance contributed to high margins?
The first thing a vet wants to know is “do you have insurance?”. Yet a vets’ representative strongly denied this affects pricing, during a radio phone-in last week. The CMA has declared vet bills have out-stripped inflation.
I notice how radio commercials for Pets in a Pickle, a relatively new insurer, became incessant last year – but now seem to have stopped. Perhaps after enough lockdown pets ended up at shelters and cost-of-living has weighed, the UK is over “peak pets” for now.
CVS’s reported operating margin varies from 4pc to 10pc over the last decade. But that is after writing off goodwill – the price paid above fixed asset values especially when “people” businesses are acquired. Adjusting for this, the last annual margin was 20pc.
I recall vets trying to justify price increases on grounds they needed to attract more people into the industry, hence pay more. CVS’s accounts do not say they have raised starting salaries but they did employ 8pc more vets in the year to June 2023.
Simple ratio comparisons may help. From CVS’s interim income statements, administrative expenses as a percentage of revenue have crept up only slightly, from 7.5pc to 8pc. But that conveys good overall financial controls, as you might expect after the chief financial officer became chief executive.
That he has a financial background originally in banking, with no veterinary experience before joining CVS in 2018, has been good for shareholders since then. But it leaves me uneasy when a regulator questions if corporate interests now dominate pet care.
Vet groups had hoped to avert an investigation by proposing a package of remedies, but implicitly the CMA does not consider them enough. The watchdog might decide to cap prescription prices, or require business disposals to reduce concentration.
That could result in a status-change for CVS with a higher portion of earnings paid out as dividends if acquisitions have to slow, it might be forced to limit takeovers to Australia. Such a process might disrupt the shares as growth investors sell and the yield has to be priced high enough to tempt income-seekers.
In its favour, CVS is a well-established business, the kind to buy into for inheritance tax relief via Aim. This ought to lend support but given an 18-month timeline with this investigation I suspect some shareholders could yet cut losses.
H&T Group shows regulatory challenges can be addressed
This company exemplifies why my caution could be overdone, although the CMA might do a more thorough job with vets than the Financial Conduct Authority’s review of pawnbroking from September 2018.
Back then, the Aim-quoted shares of H&T Group – which owns Harvey & Thompson, the UK’s largest pawnbroker – fell from over 300p to 250p by that November. Adjusting for the disruption of Covid lockdowns, its chart has broadly been upwards since (see below)
H&T fell last year chiefly because it also sells jewellery and watches whose luxury market has been pressured – for example this January’s revenue warning from retailer Watches of Switzerland Group.
Yet last Tuesday, H&T was able to declare after-tax profit up 42pc to £21m amid record demand for pawnbroking. January has set a monthly record for lending. A regulatory initiative did not therefore compromise longer-term earnings, the economy was more significant.
With the shares around 400p, the expected earnings multiple looks low at seven – chiefly because retail profits are down 19pc after the boom-bust in luxury watch prices.
Also, some investors may wonder for how long this pawnbroking bonanza can last but management says demand continues to rise due to inflation hitting people’s disposable income; and small sum, short-term credit is harder to find. The pledge book is up 28pc to £129m. All things considered, H&T appears good value.
Additionally, I recall shares in Dignity hit in 2019 by a CMA inquiry into funeral services. Despite being weighed down by debts, the company got taken over a year ago. The business came to terms with regulatory needs.
To a large extent, you have to decide if your risk appetite is high enough to engage with the uncertainty. If CVS shares continue to fester, it would attract my interest but it looks early days to prioritise them or Pets at Home.
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