Zooplus AG : Multiple growth opportunities

With soon €2bn in revenue — two-thirds of which derived from Germany — eight million customers and a 50% market share online, Zooplus AG is Europe’s leading e-retailer of pet supplies.

As the other marketplace businesses selected by our quantitative ratings — Etsy, BHG Group, Shop Apotheke: all recent additions within MarketScreener's stock portfolios — Zooplus distinguish itself by its outstanding management team and multiple growth opportunities.

Online penetration in pet supplies lags far behind other categories, but that is set to change. E-commerce is rapidly taking share from brick-and-mortar — with online sales growing at 15% per year vs. overall industry growth of 3% — due to convenience and lower prices.

That leaves significant leeway for pure players to capture market share. In another illustration of the "winner takes it all" paradigm, Zooplus' revenues skyrocketed far above market averages, growing at a — totally organic — CAGR of 27% with over 90% customer retention rates.

Traditional stores have a hard time to compete. It is difficult for consumers to buy in bulk since they have to physically carry heavy bags of pet supplies to their homes. The problem is even more acute in urban areas, where most Europeans live. The convenience of click-and-delivery wins hands down.

Zooplus also sports a structural cost advantage, unlike its brick-and-mortar competitors punished by hefty operational leverages and declining like-for-like sales. In such a commoditized business with zero switching cost for the consumer, the low-cost provider naturally prevails.

The U.S. offers an interesting case study of traditional pet supplies retailers struggling to catch up with Chewy.com — the leading pure player in North America — despite established reputations and footprints. Both Petsmart and Petco have invested large sums online, and yet they failed in taking share away from Chewy.

As about competition from Amazon, Zooplus' management claims that there is enough room for a specialist next to the retail behemoth — as evidenced by Chewy and others in different categories — in particular if it can offer a greater assortment of products and private labels at better prices.

Both Chewy and Amazon entered the pet supplies business a decade ago. Chewy also captured a 50% market share as it used to grow its top line at triple-digit rates. In Europe, Amazon's pet business remains a fraction of Zooplus'. Like its American peer, the latter seems to have carved a solid position for itself.

Due to a surge of demand for accessories and private labels, as well as economies of scale in terms of logistics and advertising, gross margins have steadily improved over the recent years. In addition, as volumes grow, the company gets better bargaining power with its suppliers, strengthening its cost advantage.

High operating leverage means that an increase of revenue coupled with a slight improvement of gross margin can produce a dramatic impact on bottom line earnings. On the other hand, EBITDA margins are still very low and it remains to be seen whether management can scale logistics enough to make the business profitable. That is where the main challenge lies.

Rising basket values also means that the lifetime value of a Zooplus' typical customer keeps growing despite a steep inflation of acquisition costs. Online ad pricing has increased because all pet supplies retailers are shifting more ad budget to online. Since 80% of Zooplus’s marketing spend is in online ads, that inflation took its toll on operating earnings.

Interestingly, management sees new customer growth as a priority, but not at any price. This discipline can be seen in marketing and advertising expenses that have stayed well under control at 3% of revenue. The real area for improvement is logistics — the elephant in the room — at about 20% of revenue. 

Valuation-wise, Chewy was acquired in 2017 for a $3.3bn price tag — or a multiple of x2 revenue. The company was admittedly growing faster than Zooplus, but it faced more aggressive competition and had to deal with a highly levered capital structure.

In that respect, Zooplus' current valuation of about x0.5 revenue looks attractive. Some would even argue that it is extremely cheap for a dominant company with an unlevered cap structure, a 50% market share in its category, enduring growth prospects of about 20-25% per year going forward, plus a clear cost advantage versus competitors and a disciplined management.

Zooplus is also the only European platform that can activate millions of pet owners with related products and services, such as insurance, grooming, veterinarians, day walking, pet keepers, etc.

That alone may be worth a premium.