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Pet Valu Holdings Ltd. (PET-T) has been a rewarding investment for many shareholders, with its stock price rallying more than 50 per cent in less than a year.

Shares of Pet Valu began trading on the Toronto Stock Exchange in June 2021 with an initial public offering price of $20. The stock price is now over $30, driven higher by the company’s strong financial results.

While the pandemic created supply chain challenges for the company, there was also an explosion in pet adoptions with ‘pandemic pets’ boosting demand for Pet Valu’s products.

In its fiscal 2021, which ended on Jan. 1 of this year, Pet Valu reported adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) of $182-mllion, up 26 per cent year-over-year. Adjusted earnings per share came in at $1.02, up from 64 cents reported in the prior year.

Earnings growth is anticipated to continue. For fiscal 2022, management forecasts adjusted earnings per share to be between $1.37 and $1.44. According to Refinitiv, the consensus estimate is $1.41 and the average target price is $41.

President and chief executive officer Richard Maltsbarger recently spoke with The Globe and Mail about the company’s financial results, supply chain challenges and management’s growth plans.

Congratulations on a very strong year. System-wide sales for fiscal 2021 came in at $998-million, just below the $1-billion mark.

We were literally one day away.

In 2021, same-store sales growth was a solid 18 per cent. In four of the past six years, you have delivered double-digit same-stores sales growth. Looking forward to fiscal 2022, you expect same-store sales growth to moderate to between 6 and 9 per cent. Is management being too conservative or is there a reason for the anticipated deceleration?

We had almost 3 million new pets adopted in the past few years in Canada, which is roughly five times the normal rate. We are expecting the industry to come back towards its longer-term run rate of around 6 plus per cent growth.

As people return to somewhat normal lives this year, we are expecting that the pace of adoptions will slow back to a more normalized pace, getting back to long-term run rates in the back half of the year.

You have a solid balance sheet with a leverage ratio of 2.1 times at year-end. Are you considering acquisitions in 2022 or are you focused instead on opening new stores as well as integrating the recently announced acquisition of Chico with 66 pet stores in Québec?

Our primary focus will be integration of the Chico acquisition, the smooth entry into Quebec and then of course continuing our organic growth across the rest of Canada.

We see ample growth opportunities. We have over 1,200 possible stores, which means we’ve got a least 500 or more to be able to open longer-term across all provinces in the future.

With the Chico acquisition, there are significant investments in the supply chain that we can add value to. A very small proportion of their business today is managed through direct wholesale distribution, which provides cost savings. They are at less than 5 per cent, we are more than 90 per cent at the rest of Pet Valu. Also, their propriety brands, which typically offer higher margins, are less than 5 per cent of sales at Chico, compared to 30 per cent at Pet Valu. There is ample growth for future stores plus the ability to leverage some of the resources and back office efficiencies that we have at Pet Valu into that business.

Looking back over the past four years, your adjusted EBITDA margin has held relatively steady in the 22 to 23 per cent range. Last quarter, the adjusted EBITDA margin came in at 23.9 per cent. For fiscal 2022, you forecast the adjusted EBITDA margin will stay around historical levels. Longer-term, do you believe these margins could increase to the mid-20 per cent level?

We don’t expect significant lift, we see small to moderate growth in our margins long-term starting in 2023.

In 2022, we are still cycling some public company costs for the first half of the year and quite frankly some pretty heightened freight and other transportation costs that are hitting all of retail, not just fuel costs but also the cost of container shipping for all imports has gone up significantly over that past year.

But we are pretty comfortable that the 22 to 23 per cent or thereabouts is the right long-term run rate. We have been able to maintain that margin while continuing to reinvest in the business.

I was surprised to see the dramatic increase in your quarterly dividend, taking it up to 6 cents per share from a penny; I thought it would be a more gradual increase over time. What type of dividend growth may investors expect to see going forward?

We are comfortable with where we raised the dividend because the biggest unknowns for us coming out of the IPO were first the pace at which we would be able to delever. We came out of the IPO wanting to get our leverage ratio below three, we’ve now worked our way down to around two. And the other unknown was the entry into Québec and what was going to be the cash and capital needs in order to make that entry. Now that both of those two unknowns have been settled that’s what gave our board the confidence to go ahead and take this larger step-up in the dividend.

As for future growth, we will consider it as part of our annual review process.

You are up to almost 2 million loyalty plan members, adding 500,000 members in 2021. Loyalty program members represented 66 per cent of system-wide sales in 2021, up from 53 per cent in 2020. Importantly, the average basket size is higher for loyalty customers; they spend more money on pet supplies. What changes to your loyalty program may be rolled out to further increase the average basket size and attract additional members?

Just to give you a history, when I entered the company in 2018, the majority of our loyalty program was paper based, little cards in a rolodex underneath the cash register on a per store basis.

In 2020, we significantly invested in the loyalty program and digitized the system, that’s what contributed to the loyalty penetration growing from 43 per cent in fiscal 2018 to 53 per cent by the end of 2020. Further digitization helped our loyalty penetration reach 66 per cent of sales by the end of 2021 and we continue to see growth. I give that background to you to let you know just how nascent our digital loyalty capabilities are being less than two and a half years old.

What we are building into the system now is a greater level of analytics. During 2021, we introduced our first trigger based programs for both retention and other promotions as well as our first reminder based programs for the free bags of dog and cat food and free dog washes that comes as part of our frequent buyer program.

This year, we are adding incremental benefits for non- dog and cat owners, so for small animals such as rabbits or hamsters we are adding frequent buyer programs for some of the supplies.

Would you ever consider a point based loyalty program where consumers receive points and cash discounts?

I come from an analytics background, even before working at Lowe’s, back in the IBM days and earlier so I understand the value of the different types of programs. However, given all the other priorities we’ve had that’s not at the top of the list.

Your proprietary brand penetration is high at over 30 per cent of system-wide sales. How much can that grow?

We have over 7,000 total SKUs [stock keeping units] that we offer across the network, more than 1,500 of them are propriety brands in all type of categories, food, treats, supplies, anything from grooming tools to shampoo to crates to our holiday toys. We really have a pretty extensive line-up.

Yet, our hardlines penetration of propriety brands is still about half of what global benchmarks would indicate is possible for us to introduce in hardlines. So we brought on an incremental product development team last year to further take us into the hardlines space. [Hardlines are non-consumables and non-services, such as beds, crates, clothing, and litter.]

With respect to private label offerings, are there any verticals that you are not in and may introduce new products?

We have very limited verticals where we are not currently in but we have some verticals where we only barely scratch the surface. An example would be specialty animal. So if I go to aquatics, today we are primarily only in fish food, there’s a significant amount of supplies that support aquatics other than just fish food. So it’s not so much brand new categories, it’s the depth of the categories and the breadth that we can offer across multiple different brands.

Where could you expand your breadth with dogs and cats?

We have incremental toy opportunities across all different types of toys and incremental seasonal opportunities. We had a really great lineup of fall and winter seasonal apparel that we brought in for Christmas that flew off the shelves so we see a great opportunity to continue to expand that. And then, within dog and cats specifically from a food perspective, we’ve only recently introduced our opening price point proprietary brands in 2019, which would be Barker’s and Lovibles, and we only recently introduced our Performatrin Naturals, which would be similar to a Blue Buffalo, we only introduced that in 2020. Even within our most established brand, Performatrin, which has been in our stores for 35 years, we just rolled out an incremental sensitive skin and stomach profile into our scientific diet.

Right now, 68 per cent of your sales are consumables, food and treats, and 30 per cent are hardlines and specialty, and 2 per cent are in-store services. How do you see that product mix evolving?

I don’t imagine it’s going to change too significantly. I would argue that that’s a pretty consistent mix. The 68 per cent for the food and treats really brings in that recurring monthly revenue.

A stated objective is to increase the store count from over 700 stores to 1,200 in the next 15 to 20 years. Pet Valu opened a record 30 stores in 2021 and you plan to open 30 to 45 stores in 2022, of which 5 to 10 will be under the Chico banner. When you open these new stores will you also be increasing the average square footage of a store to house more products and services?

No. Our average and target footprint is around 3,500 to around 4,000 square feet. Within that footprint it allows us the most flexibility by market. Let me give you an example, so let’s say you are in downtown Toronto and there might be a redevelopment of a high-rise, that 3,500 to 4,000 is a sweet spot for being a first floor retailer in a multi-unit high-rise so that really works well on our metro market infill.

It also works very well in rural Canada, where 4,000 square feet is about the right size. The store configuration is different, a little less breadth and larger volume SKUs – there’s a lot of big dogs in rural Canada so a lot of large bags of food in rural Canada. So the same footprint but laid out differently, which allows us to go into a small market where a competitor that has a much larger footprint really can’t make the economics work in a small town but we can.

Will the new stores be mostly in urban, suburban or rural markets? Is the urban market saturated?

We still see opportunities in all types of markets.

There are still pockets in the GTA where we have the opportunity to continue to infill. Having said that, most of the opportunity for us to grow is in the rural market and suburbs. There are a lot of small towns in Canada.

Your capex forecast for fiscal 2022 is between $20 to $25 million, what is the breakdown for your capital spending plans?

So it’s primarily for new stores and renovations that’s our first and foremost use of cash. Secondarily, there’s capital for the supply chain, so the ongoing reinvestment in material handling equipment, trucks, trailers, etc.

We also have a significant amount of cash being invested in IT. We’ve put over $35-million into our technology transformation to-date over the past three years. If you look at our non-recurring adjustments over the last three years, you will see the bulk of that $35-million of investment is actually not in capital expenditures but as a non-recurring IT charge.

With COVID restrictions lifting and a steady resumption of normal activities, are competitive pressures intensifying?

We are still seeing a very rational promotional environment. We are still seeing roughly the same pace of competitive openings as we saw in the pre-pandemic era. This is the lowest promotional environment that we’ve actually ever seen within the pet industry.

The primary shift in the environment has been the difficulty that all of us in the industry are going through with the challenges of supply and the increase costs of freight and transportation.

Are supply chain challenges simply out of your control and are conditions improving?

There are specific ingredients and specific packaging material outages that are for the most part out of the industry’s control. Most particularly, plastics, aluminum, specific raw ingredients such as venison will come in and out depending upon the different global interruptions.

What we have done to help control this, we’ve significantly lifted our overall inventory levels to extend our safety stock and we’ve gotten much more specific with our leading vendors and especially our proprietary brand vendors in the daily production calibration to ensure what they are producing is lining up with what we are demanding.

It’s not improving then. Is it getting worse or is it unchanged from a couple of months ago?

It’s still roughly the same. Having stated that, it’s intermittent across different challenges. So there’s no one persistent challenge I would say that has hit the pet industry for this whole time, it’s just the intermittent interruptions caused by relatively one off disruptions throughout the world. Case in point, rail outage in Wyoming reduces the available clay to feed cat litter. You have to go all the way back to the raw ingredients. If you have to get clay out of a mine and put it on a railcar, if snow in Wyoming blocks the rail, you are going to have an ingredient shortage with your manufacturer.

The biggest and one thing that is specific and persistent is the increase in freight costs, most especially importation from Asia.

Can you talk about the new larger warehouse facility that you expect to be completed next year and how will this help the company’s profitability?

Today, we service all of Ontario and eastern Canada, excluding Chico because we just acquired them, out of a series of two major warehouses plus a few smaller dock centres and a few third-party facilities in Ontario. We expect our new GTA facility to be in service around mid-2023 with full consolidation in early 2024.

When you collapse your operations from seven different facilities to a single larger, partially automated facility, we will be able to reduce unit costs and achieve a greater level of handling productivity but not until we fully consolidate in early 2024.

With very high inflation that investors are facing and consumers’ resistance to change brands, do you see the company adjusted its pricing strategy?

We are very comfortable with the strategy that we have today. We believe the service levels that we provide justify the incremental premium where they do exist. On our direct reference competitors, we are usually anywhere from 5 per cent above to 5 per cent below on price. The incremental value that we provide is in our proprietary brands where should someone want a similar nutritional panel at a 10 to 20 per cent discount, our Animal Care Experts, or ACEs as we call them, are in a position to help them.

People have a tendency not to want to change their brands but when they do, we see a disproportionate change to our proprietary brands.

What level of price increases may shoppers see in 2022?

It will really flow with whatever cost increases that we find from the market place. There is no specific target that we have. We work very hard to challenge any cost increases first and foremost and then when they do come in we follow our competitive actions very closely.

With your recent acquisition of Chico, you’ve established a new presence in Québec. How is the Québec market different from other markets? Is there a lower average basket size there?

At Chico, they do not have a significantly lower basket size than what we see in our current business. Again, with our very high level of service and expertise, we see a very similar add-on and basket capability at a Chico store - the reason why they were the best choice for us to partner with.

Québec is a more fragmented market with a significantly higher number of small independents, and also small, four to seven, store chains than what you see across the rest of Canada. This has created the opportunity for Chico to step into new markets and bring an improved level of service and mix than what customers in many markets are used to seeing.

To conclude the interview, I have a couple of personal questions. You grew up in a rural town in Missouri and graduated with a master’s degree in agricultural economics from the University of Missouri. How did you end up the CEO of Pet Valu?

I grew up in agriculture and always loved the food industry. We grew up raising cattle as well as corn, soybeans and wheat. But at the same time, I also started programming computers when I was eight years old. So I grew up both a farmer and a computer programmer during the 80s, when that was the cool thing to do.

So I started programming websites in the mid-90s, and that led me towards a technology bent for quantitative analytics, which led me to IBM. At IBM, retailers became part of my client set. North Carolina was a beautiful place to live when you decide to start a family and so I joined Lowe’s. I started in the quantitative analytics and research area but over time really fell in love with the dynamic nature of retail and the direct interaction with consumers. So when I had the opportunity in 2018 to look for what was next, Pet Valu had it all. It was in the agriculture and food industry, it needed a significant technology migration, which tapped into my IT background, it had a franchise base, which is very similar to the agriculture co-operatives that I grew up around in Missouri, and a significant amount of both urban, my wife is from New York City, and rural, because I am from the middle of nowhere in Missouri, and my kids thought it was super cool that their dad was going to work at the pet store. So it had everything going for it.

One last question, I know you are a 4-H alum from Pettis Country, Missouri. The 4-H slogan is “Learn by doing” and their motto is “To make the best better”. What motto do you live by?

Family first, opportunity second, integrity third. As long as you maintain integrity based decisions, the rest of life has a tendency to fall into place.

This interview has been edited and condensed.

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