Well played thunderhead, and well done for wanting to digest...

Well played thunderhead, and well done for wanting to digest this first. I also took no action as an existing holder until I had digested it. Having now looked closely at the implications, these are the facts as I see it:

A. Negatives:

1. Underlying FY18 EBITDA down to $97-100M, from FY17 result of $103M (adjusted for 52 weeks), and from market expectation of an increase of around 6% (I think). So, total reduction from market is around 10% (8-11%). As we will see below, most of this is isolated to FY18.

2. Capital impairments of $16-20M. This will impact on statutory profit this year only. It amounts to a reduction in equity of around 4%, and a similar increase in gearing because of the reduction in equity. Gearing has actually gone up by more than this, see below.

3. Standalone vet GP LFL down by 2.8%. This was unexpected, and is a rare occurrence. I note that this has now stabilised, so could be regarded as a one-off. There may be some customers moving from standalone clinics to new in-store clinics nearby, as indicated by very strong double digit growth of LFL at in-store clinics. Overall, total vet LFL was 4.9% compared with 4.8% in FY17, so not a major issue at all.

4. Project problems leading to a $4M hit to EBITDA after expensing labour costs rather than capitalising them as done previously. This should only be a FY18 issue, and is probably a good thing if capital is better allocated in future, and expenses are lower due to stopping some dud projects.

5. Unbudgeted rental expense due to reversal of an onerous lease adjustment in the first half. This leads to $0.6M expense ongoing, but presumably the stores will be profitable, or the reversal should not have taken place.

6. Net debt has increased from $239M to $280M, or up 17%. This is my biggest concern, and reinforces the need for changes now being made. The new CEO will be much more hard-nosed about capital expenditure, and needs to start paying down debt rather than increasing it. I would be much happier if he could get this down below 30% gearing (from around 36% now) before the next debt refinancing in 2 years.

7. The previous use of a short-term credit facility to delay supplier payments. This was clearly done to improve appearances, and I am heartened that this practise has been stopped. This may result in a one-off hit to working capital and therefore profit this year, but should also reduce net debt.

B. Positives:

1. There is minimal change in trading conditions compared with FY17. Aust retail LFL down from 4.4% to 4.3%. Aust vet LFL up from 4.8% to 4.9%. NZ LFL down from 4.9% to 4.2%. All good IMO. These kinds of fluctuation occur all the time and still reflect healthy above-inflation growth.

2. New CEO moving away from a previously capital intensive model (e.g. unnecessary changed to physical layouts). This should lead to improved returns on capital expended and no need to raise debt any further.

3. Reduction in operating costs of $10-$13M annually.

4. The CEO has confirmed the outlook for long-term growth.

C. My Conclusion:

After a 10% dip in underlying EBITDA this FY, it should bounce back in FY19 based on the one-off nature of most of the announced negatives, and based on the operating cost reductions to come. Suppose underlying EBITDA this FY is $98M, and operating cost reductions of $11M are achieved, then the underlying figure for FY19 should be around $109M if there is no other source of underlying profit growth. But there are several other sources of profit growth including the new CEO's mindset, continuing investments being made, improving returns on new stores and clinics as they mature, and continuing strong LFL performance well above inflation. It should not be unreasonable to expect a FY19 underlying EBITDA of closer to $115M - an all-time record. This compares with the FY17 outcome of $103M, which was then a record. Even if it takes another FY to get to this level, (only 14 months away) EV/underlying EBITDA at the current share price would then be around 4.4, very good value IMO.