Lex Populi is a new FT Money column from Lex, the FT’s daily commentary service on global capital. Lex Populi aims to provide fresh insights for seasoned private investors while demystifying financial analysis for newcomers. [email protected]
Bosses love to expand the companies they run. Many investors’ response was, “Stay focused: It’s my job to reduce risk through diversification, not yours.” This could apply to Pets at Home, a UK-based food and accessory retailer keen to expand its market.
Aspiring CEO Lyssa McGowan can point to half-year results this week to support the horizontal spread. Pets at Home has expanded its veterinary business after a costly restructuring a few years ago. It is making an increasing contribution to revenue and profits.
Economies of scale are often cited as a reason for grouping of companies. Large companies can purchase supplies more cheaply and spread head office costs over a larger revenue base.
Diversification can also create dynasties. For example, hotel operator Whitbread has been under investor pressure for years regarding its fast-growing coffee shop chain. It finally sold the Costa Coffee brand to Coca-Cola for $5.1 billion in 2019.
In the same vein, Associated British Foods might also be called Associated British Clothes, as one FT colleague quipped. The city is more interested in Primark clothing stores. Being in control of the family means there is no potential split.
Lakes believes that pragmatism applies to diverse works, which critics sometimes reflexively dismiss as “conglomerates”. Diverting cash flow from mature divisions into fast-growing projects can make sense. Why not, as long as the group is doing well?
House pets also enjoy defending their versatility to neighborhood activities rather than flinging them far and wide. Its three brands — Pets at Home, Vets4 Pets, and The Groom Room — share an online platform and often the same physical location.
The group plans to further diversify. This week, McGowan noticed the “huge space” between shipping a bag of dog food and performing surgery on a cat. She talked about nutrition, wellbeing, preventive medicine, household items, accessories, end-of-life care, and coaching. It said growth will be organic and through “increased merger and acquisition opportunities.”
McGowan joined six months ago from Sky, where she was Head of Consumer. Her digital marketing expertise should support the company’s strategy for building digital revenue, particularly through online subscriptions. The company’s Puppy and Kitten Club has 7.6 million active members.
Leakes previously questioned whether the UK’s pet spending epidemic would survive the end of lockdowns. Pets in the House kept up the sales momentum. Comparable revenue likewise rose 6.4 percent in the first half of the year compared to April, with most of the growth coming in the second quarter. Profit before tax fell 9.3 per cent to £59.2m – in line with expectations and explained by an 11.3 per cent rise in core operating costs from energy, shipping and digital investment.
At around 290p, shares were below their pre-pandemic peak and well below their high of around 520p in September last year. The company is trading at about 14.5 times future earnings. For much of 2020, its valuation was double that or more. Stocks are a decent medium term investment. But McGowan should focus on building the veterinary business before working through his long shopping list for new projects.
50 shades of green
Amundi, Europe’s largest fund manager, caused turmoil. It has declassified the majority of its “really green” $45 billion to “sort of green.” This highlights one of the problems with ESG investing: It is not yet clear what is a sustainable place to put one’s money. There are other—more fundamental—concerns, too.
Lex believes that the E, S, and G of the ESG are made up of categories that don’t belong together. Environmental investment has scope for good returns because the energy transition is necessary and inevitable. The social benefit is a more ambiguous good deal – note the moves to reclassify defense stocks as ESG shares. Judgment is often a check in the box.
Within environmental investing, the question is what should qualify. Regulators do not want money management groups to classify their funds as sustainable if they are not. Germany’s DWS has faced accusations of such greenwashing this year.
The Sustainable Finance Disclosure Regulation (SFDR) and Classification in Europe define what should be considered green. Funds should be forced to classify themselves according to their underlying investments. These policies should enable investors to put their money to good use in a measurable way.
There is some evidence of success. More than 50 percent of European funds are rated Article 8 (light green) or 9 (dark green). However, the evolving guidance meant 380 products changed ratings in the third quarter, according to Morningstar research. This is what Amundi and some of her peers did, in part to avoid legal challenges later.
The real question for investors is: To what extent can green investments yield higher risk-adjusted returns and help save the world in the process?
For the first point, environmental investments should have lower growth potential and risks. They will continue to suffer from economic cycles. In fact, since the start of 2021, sectors often excluded from green boxes — oil and gas, for example — have outperformed the broader market and renewable electricity.
As for saving the world, the risk for any investor is that the categories set by bodies such as the European Union may not align with their own definitions. Use it as evidence rather than gospel truth. Dirty companies that turn into clean companies may be more investment-worthy than failed offerings laden with ESG awards.
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