Description

Insiders sell for many reasons, but they only buy for one.  

Shares of Zooplus, the leading online retailer of pet supplies in Europe, are down 40% since May 2018.  With sales growth decelerating amidst competitive concerns, investors have largely given up on Zooplus. I believe the fear of competition is overblown and shares are cheap at just 0.6x TTM sales.  The Zooplus CEO agrees and is voting with his wallet, having spent over €730K since the end of January buying shares for his personal account. New customer account growth, a leading sales growth indicator, accelerated in Q418 for the first time in a year.  I believe sales growth acceleration should follow in 2019. I see upside to the stock of over €300/share, using a discounted TTM sales multiple of 1.6x vs. 3.7x TTM and 2.2x NTM paid for Chewy, a comparable online retailer of pet supplies in U.S.

Zooplus was pitched by CFL41 as a long idea on VIC back in July 2017.  Rather than rehashing CFL’s pitch, I will focus on what has transpired since then.

Why is the stock down?

• Sales growth deceleration: While sales have decelerated from 30%+ in 2015, Zooplus has consistently delivered growth in the 20-30% range until Q318 when sales fell below 20% for two consecutive quarters (see Chart 1).  The slower rate of growth has fed into investor concerns over competitive pressure, particularly from Amazon.

Chart 1: Sales Growth Y/Y

• Underperformance of European peers: Shares of two large pure-play online retailers in Europe have significantly underperformed since September 2018, thus dragging down many European e-commerce stocks. Shares of Zalando, a European online store that sells fashion and beauty products, are down more than 20% since negatively revising its 2018 guidance in September. Shares of Asos, a British online fashion and cosmetic retailer, are also down more than 20% since reporting disappointing results in December.

   

• European macro concerns / Brexit: The European economy is slowing down with the risk of recession rising. Combined with uncertainty over Brexit, investors have little appetite for the stocks of European companies that are not firing on all cylinders.

Why is now the time to buy?

• CEO buying stock aggressively: Founder and CEO Cornelius Patt has an excellent track record of timing his purchases and sales of Zooplus shares (see Appendix).  In late 2015, he sold shares at around €140/share. In late 2016, he bought shares back at around €120/share. In May 2017, he sold shares at around €180-184/share. In October 2017, he bought back shares at around €140/share. In May 2018, he sold shares at around €180/share. Since the end of January 2019, he has purchased over €730,000 worth of shares at around €110/share. Mimicking Zooplus CEO’s trades would have been very profitable.

• Other insider purchases: CEO Patt is not the only insider who has purchased shares recently.  Director Karl-Heinz Holland bought over €130,000 worth of shares at €130/share in November 2018. Chairman Christian Stahl bought €225,000 worth of shares at €150/share in September 2018.  Admittedly, the timing of these two purchases were not as good as that of the CEO’s recent purchases near the bottom.

• New customer account growth acceleration: I believe new customer account growth, combined with a loyal customer base, is a good predictor of future sales growth.  Zooplus has historically maintained high levels of customer loyalty with sales retention rate above 90% (see Chart 2). The company defines sales retention rate as recurring sales in the financial year from existing and new customers in the prior year as a percentage of the previous year’s sales.  New customer account growth decelerated dramatically in Q218 and Q318, leading sales growth to decelerate below 20% (see Chart 3). Management attributed the slowdown to tougher comparisons, lower mobile conversion and reduced customer acquisition spend. New customer account growth reaccelerated in Q418 as management increased marketing activities. As a result, I believe sales growth should re-accelerate in Q1 or Q2 of 2019.

Chart 2: Sales Retention Rate

Chart 3: New Customer Account vs Sales Growth Y/Y

• Gross margin stabilized / expanding: Zooplus often highlights competitive pressures in its earnings reports.  To maintain price leadership and increase market share, Zooplus sacrificed gross margin, which declined from 38% in 2010 to 24% in 2017.  However, gross margin has not only stabilized since 2017, it has expanded in recent quarters (see Chart 4). Management cited less discounting, reduction of non-profitable orders and better sourcing. In addition, I believe competitive pressures have abated. According to JPMorgan’s recent price checks, “the bricks-and-mortar operators have behaved more rationally in the last four months, after an aggressive move over the summer. Overall, the price gap versus Zooplus had remained broadly stable at 6% in Jan-19 where it had been since Oct-18.” (see Chart 5)

Chart 4: Gross Margin Trend

Chart 5: Shopping Basket Price Comparison (source: JPMorgan)

Valuation

Since it is reinvesting for growth, Zooplus generates little profit today. As such, I believe EV/sales is the more appropriate valuation metric for Zooplus. In June 2017, PetSmart acquired Chewy, a U.S. online retailer of pet supplies, for $3.35 billion at 3.7x TTM sales and 2.2x NTM sales. By applying a TTM sales multiple of 1.6x (a conservative discount to Chewy’s transaction multiples), I arrive at an equity value of €300/share (170% upside).

Risks

• Amazon: The online behemoth is perhaps the biggest threat to Zooplus given its scale and ability to compete on price. Amazon has been competing with Zooplus for a long time in Europe.  Yet, Zooplus has continued to grow at a solid pace with 50% online pet supplies market share and €1.3B in annual sales. If Amazon were going to put Zooplus out of business, it would have done so by now.  Clearly, Zooplus has proven to be a nimble operator with competitive advantages.

   

• European macro: If Europe were to go into a recession, Zooplus sales would likely be negatively impacted.  However, I believe Zooplus is better positioned than its competitors in such a scenario due to its online scale.

Appendix: CEO’s insider activity since 2015

Source: http://investors.zooplus.com/en/corporate-governance/directors-dealings.html 

Catalyst

Insider buying

Sales growth reacceleration

Capital market day on March 20, 2019