Broker tips: Pets At Home, Sainsbury's, Dunelm

(Sharecast News) - Pets at Home shares tumbled on Monday as RBC Capital Markets downgraded the shares to 'underperform' from 'sector perform' and slashed the price target to 280p from 330p, partly on valuation grounds. The bank said PETS has a strong position as a specialist player in the UK pet care market. "However, we believe valuation looks full and consensus forecasts look demanding.

"We expect further earnings growth to be more challenging to achieve given mounting pressures on the consumer and a wider spend rotation away from 'pandemic-winning' categories. Hence, we downgrade to underperform."

RBC said current consensus is looking for circa 2% earnings per share growth in FY23, with a further 12% growth in FY24. "Even with investments coming down in FY24 and PETS' more defensive offering, we think that this looks challenging to achieve, given pressured consumer budgets and margin headwinds," it said.

It noted the shares currently trade at around 15x CY23 estimated price-to-earnings, towards the middle of the historic range.

"We note that this is at a premium to others in the UK retail space, and looks demanding for a retailer with 100% UK exposure, at a time when consumer spending is under pressure," RBC said. "We have more valuation upside for some other UK retailers at these levels, such as JD Sports and WH Smith."

RBC said the company has benefited over the last two years from its market-leading position in a sector that has seen strong growth. According to data from Statista, 62% of UK households now own a pet, compared to around 40% before the -pandemic, it said.

"Whilst we think that the defensive nature of pet care should provide PETS with some topline resilience, we think that further growth will now be more difficult to achieve in the light of rising cost of living and the benefits from higher spend on new pets fading away."

RBC Capital Markets also downgraded homeware retailer Dunelm on Monday to 'sector perform' from 'outperform' and cut its price target on the stock to 950.0p from 1,400.0p, saying it expects margins to moderate.

"We view Dunelm as a market leading specialist UK homewares retailer, with a strong range advantage and good price architecture," it said. "However, we expect margins to moderate near term given more normalised promotional activity and input cost pressure."

The bank said Dunelm's margins have likely been temporarily supported over the last two years by a lower level of discounting given higher demand and tighter stock availability. "We expect Dunelm to return to a more normalised sale profile in FY23, with two sales in H2. In total, we forecast circa 130bps of gross margin decline in FY23."

RBC said the outlook for the topline also looks tougher now given a more pressured consumer and likely spend rotation away from homewares and bigger ticket, more discretionary purchases.

It said that although consumer spending in homewares has remained above 2019 levels so far in 2022, it has begun to see declining trends in recent months.

"We believe that this trend will continue, given an ongoing recovery in areas like fashion and travel. Furthermore, mounting pressure on consumer wallets will likely weigh on discretionary income, particularly for big ticket purchases such as furniture, which has been a growing part of Dunelm's mix in recent years (we estimate c.10-15% now)."

As such, the bank reckons it will be more challenging for Dunelm to grow its earnings near term, hence the downgrade.

Analysts at JP Morgan Cazenove reiterated their 'underweight' rating on supermarket giant Sainsbury's on Monday and said there were still "several reasons to remain cautious" of the stock.

JP Morgan said it had analysed the firm's "most pertinent bottom-up KPIs" against the backdrop of current market dynamics and pointed out that it likes Sainsbury's readiness to invest in prices to protect its customers, its ongoing cost optimisation programme, and its "attractive" dividend yield, supported by comfortable leverage and solid free cash flow generation within the core retail business,

However, JPM noted that Sainsbury's lack of organic growth, "challenging" sales densities outlook, "weak" market share trends, high exposure to non-food items, deteriorating value creation potential, operating deleverage in the context of thin margins and high expectations, and lack of valuation upside, had all forced it to remain "cautious" on the stock.

JPM also reiterated its 190.0p target price on the stock.