Woolworths set to become the pet retailing king: Brokers opinions split

Woolworths (ASX: WOW) is set to become an undisputed heavyweight in the Australian pet market after purchasing a 55% stake in Petspiration Group for $586 million.

Petspiration is the owner and operator of leading retail brand PETstock which has a network of 276 stores and 2.4 million members. The sector is consolidating rather quickly, with Petspiration acquiring major pet retailers My Pet Warehouse and Best Friends Pet earlier this year.

“Specialty pet is a large and growing retail segment in which we have limited presence," said CEO Brad Banducci, adding that "specialty pet is a logical adjacency given the high penetration of pet ownership across Australia and New Zealand."

Transaction at a glance

Earlier this week, Woolworths sold a 5.5% stake in Endeavour Group (ASX: EDV) via a block trade worth $636 million – a timely sale to fund this $586 million purchase.

Notable details of the transaction include:

• Petspiration founders and existing shareholders to retain a 45% interest

• The transaction values the company at approximately $1.7 billion

• Petspiration generated $158 million in EBITDA over the last twelve months to September 2022, valuating the company at 11 times earnings

• "Investment expected to deliver strong returns for shareholders with an internal rate of return (IRR) in the mid-teens"

Divided brokers: One Buy, One Sell

Goldman Sachs said the acquisition was an "incrementally positive step in the evolution of Woolworth's eco-system strategy."

"The transition from liquor retail and gaming/hotels into higher growth, and closer synergies with the family shopper pet retail is in line with its strategy of building a reinforcing retail ecosystem," the investment bank said in a note on Friday.

A BUY rating with a $41.70 target price was retained for Woolworths.

JPMorgan's commentary was a complete U-turn, describing the transaction as "questionable capital allocation."

"We question the strategic capital allocation decisions given the price of the acquisition and the ability to add meaningful value to the business over the mid-teens IRR as it will not be integrated with Australian Food," said JPMorgan analysts in a note on Friday.

The pet category experienced a pull forward in demand due to a jump in pet ownership during the pandemic, according to the analysts.

They criticised the life time value of pets, as its naturally shorter than that of shoppers, and heavily weighted towards the first one to two years. Margins were also in the firing line, as Petspiration was generating margins of 16.1% over the last twelve months (versus ~9% for Australia supermarkets) which indicates "challenges in generating upside."

JPMorgan retained an UNDERWEIGHT rating for Woolworths with a $31.10 target price.