CVS’s pet growth project

Vet market consolidator CVS offers investors exciting acquisition-driven growth in a market continuing to demonstrate high-levels of recessionary resilience, writes James Crux

Established in 1999 and floated on AIM in October 2007, with a £93 million fundraising priced at 205p, veterinary services provider CVS Group is pursuing a highly successful, high-growth buy-and-build strategy in a resilient market.

Based in Diss, Norfolk, CVS, whose fortunes are driven by proven business builder Simon Innes, has established a track record of delivering against its financial and strategic targets. Against a backdrop of recession, the strongly cash-generative company managed to grow pre-tax profits by 53 per cent in the year to last June, showcasing the defensive nature of its earnings.

Furthermore, despite being the UK’s largest national operator and consolidator of veterinary practices with circa 170 practices and growing, the company speaks for a modest 7 to 8 per cent of its chosen small animal sector, leaving plenty of growth to go for.

Given its market-leading position, reputation and funding firepower, CVS is the ‘acquirer of choice’ for a wave of veterinary surgery vendors that find their traditional exit route – younger partners buying into practices or taking over – unavailable, as demographics in the veterinary profession continue to change.

With a strong pipeline of acquisitions under evaluation, CVS continues to demonstrate its recession-resistant characteristics and offers investors exposure to defensive, double-digit earnings growth at an undemanding price.

Strategy
Under boss Simon Innes and finance director Paul Coxon, CVS is on a busy buy-and-build mission focused on the small animal end of the veterinary services market.

The company’s acquisition model is being driven by the demographic changes under way within the increasingly female-dominated veterinary profession. This is seeing experienced veterinarians, who have built up their practices over time, unable to entice the younger generation of vets into taking over or buying into their businesses.
As Coxon elaborates, ‘Younger vets today, male and female, are now less inclined to buy into partnerships. And with the 50-something vets looking to slow down or secure their nest egg, that means their natural exit route is no longer there.’

As the well-funded, biggest UK player in this fragmented sector, with an excellent industry reputation, CVS is seeing willing veterinary vendors knocking on its door, rather than the other way around, with all the inherent pricing advantages that brings.

‘We wait, and they come to us,’ enthuses Coxon, adding that CVS pays cash for the vet practices it buys and vets are keen to stay on with their practice after it is sold. ‘All of our acquisitions since December 2008 have been financed solely from cash,’ he adds.

Since coming to market in 2007, CVS has acquired more than 40 surgeries and a number of veterinary laboratories, and in the year to last June purchased and integrated a further 17 surgeries. This took the year-end total to 168 surgeries nationwide (home to 393 vets), with the company boasting six diagnostic laboratories and buying its first pet crematorium and cemetery during the year.

Much strategic emphasis is placed on enhancing the margins of acquired practices, with CVS taking over their management through its own central facilities and leveraging its ever-growing buying power. ‘What we do is buy well-established businesses and strip out the inefficiencies,’ explains Coxon. Activities such as HR, marketing, payroll and purchasing are incorporated into what he describes as CVS’s ‘central function’, freeing up the vets to concentrate on treating animals and significantly boosting the profitability of the acquired business and group.

‘In terms of gross margin generation,’ says Coxon, ‘we can put 7 to 10 per cent on the bottom line solely on buying products at better prices.’ And as a result, acquisitions see ‘a significant enhancement in profits in year one’.
Management also aims to maximise sales and capture a greater share of margin via the addition of complementary businesses, such as the veterinary laboratories, to which the CVS vet practices send their lab work. The laboratories business contributed a significant £8.3 million of sales last year, offers diagnostic services including microbiology, clinical chemistry and histopathology and generates 20 per cent of its business from intra-group practices.

Management
Occupying the hot seat at CVS is Simon Innes, the former Hamleys and Marks & Spencer man, appointed as CEO at the beginning of 2004 in the days before CVS’s AIM float. Innes is a well-followed entrepreneur, best known in business circles as the man who, between 2000 and 2004, built up Vision Express into a £220 million turnover business with 205 practices. During his stint, he turned the company around from losses and into one of the most profitable corporate optical chains in the UK.

Armed with his Vision Express experience, Innes, who in his earlier years served for seven years in the British Army, is successfully repeating the trick in the veterinary industry with CVS.

Overseeing developments from the non-executive chair is Richard Connell, who brings his financial sector knowledge to the boardroom table, having formerly worked at the likes of HSBC, 3i and Amvescap. Aside from CVS, the Oxford-educated Connell also chairs acquisitive funeral services specialist Dignity, listed on London’s main board.

Since his appointment in the summer of 2003, amiable finance director Paul Coxon has been in charge of CVS’s ever-improving numbers. Coxon, with around 20 years of experience in financing and accounting, is used to handling the finances of some substantial growth businesses. In his pre-CVS days, he was the finance director of Allied Grain (South), a £160 million turnover subsidiary of Associated British Foods.

On the non-executive side, the company can call upon the services of suitably qualified former Genus numbers man David Timmins. During his time at Genus, he played a prominent role in the reverse takeover of a rival company, which involved a significant fundraising from institutions, and picked up knowledge of the veterinary sector through one of Genus’s divisions.

Prospects
CVS is strongly positioned to nurture healthy, acquisitive growth rates in the attractive veterinary services market. Despite already being the UK number one, there is still plenty of growth for CVS to go for, since its share of its chosen small animal sector remains very small at between 7 and 8 per cent and it is the most attractive acquirer to vet vendors. ‘There are over 4,000 veterinary practices in the UK and 2,300 of them are small animal practices,’ points out Coxon. ‘We have 170, which is over three times more than our nearest competitor’.

With less than 20 per cent of the small animal surgery sector presently under corporate ownership, CVS is seeing a healthy pipeline of available takeover targets and is in pole position to deliver future growth through takeovers given its funding firepower.

Prospects are further underpinned by the resilient, dependable nature of earnings in this market, which stems from the emotional attachment owners have to their pets. Although more prudent pet owners might stop paying for non-essential treatments or vaccines when the economy turns down, they will always tend to take their beloved animal to the vet if it falls ill, which means CVS’s earnings are highly defensive.

Full-year results, announced back in September, reflected this resilience, with CVS reporting improvements in sales, profits and cash flow in the midst of a severe recession. Pre-tax profits moved an impressive 53 per cent higher to £8.4 million, and earnings per share expanded by 44 per cent to 11.5p. Turnover grew by 23 per cent to £76.6 million and modest but welcome like-for-like growth of 2 per cent allayed any fears investors may have had about the impact of the downturn on the company’s market.

Furthermore, CVS generated a dramatically improved £12.4 million of cash from operations, and while the company finished the period with £40.8 million of net debt, analysts believe debt levels should reduce to £38 million by June.

This year, CVS has continued to expand organically and by acquisition, with the latest takeover being that of Warrington-based Rees Veterinary Clinic, which made £87,000 pre-tax on £643,000 turnover in the year to last June. Moreover, trading has continued in line with expectations at a time when small-cap companies in less defensive sectors have been forced to issue profit warnings. As Coxon assures, ‘The veterinary business is very solid and
we are still delivering growth.’

Valuation
For the current year, City analysts argue that CVS can grow its adjusted pre-tax profits by 31 per cent, from £8.3 million to £10.9 million, as turnover increases to more than £88 million (2009: £76.6 million). And in spite of wider economic malaise, earnings are forecast to burgeon by an impressive 35 per cent to 14.9p.

Estimates for 2011 suggest that investors should look for 21 per cent growth in profits to £13.2 million pre-tax and 21 per cent year-on-year earnings growth to 18.1p, as sales approach the £100 million milestone.

Based on those metrics, the shares, which have retreated from the 280p level they reached in 2008, are trading on a relatively undemanding prospective p/e of 12.4, falling to 10.2 for 2011 – a discounted rating to related, though not like-for-like, peers including Dechra Pharmaceuticals and funerals business Dignity.

More telling is the undemanding price/earnings-to-growth (PEG) ratio of 0.35, which suggests good value abounds given the growth CVS is confidently expected to deliver in its fragmented and defensive chosen market. Given the recession-proof growth the business is delivering and its prime positioning for further swiftly earnings-enhancing deals, we think a rerating is now overdue. The shares are a strong buy.