PetSmart: A Pup With a Plan
Remember when Barbara Walters was lampooned for asking Katherine Hepburn what kind of tree she would be? Forgive us if we follow roughly the same tack as we look at the stock in PetSmart, the Phoenix-based retailer of pet products and services with 860 stores in the U.S. and Canada. PetSmart (symbol PETM) drew our interest after Wachovia Securities became another of the stock's fans, initiating coverage on September 18 with a buy recommendation and a 12-month price target of $31 to $32 a share. The stock closed at $28.08 on September 19.
But the story behind this up-and-down stock got us thinking: If PetSmart were a dog, what kind of dog would it be? The first thing that comes to mind is scrappy, like a terrier, and maybe nosy, like a bloodhound. The company entered into the bidding process when its arch rival, Petco, put itself on the block. PetSmart dropped out but forced the price up for the eventual buyers, and no doubt gained some competitive insights in the process. Next thing you know, PetSmart is announcing this summer that it is accelerating plans to invest in improvements in technology, distribution and employee training -- just when its main competitor is likely to be working off debt and spending little, maybe even raising prices. Though costly now, PetSmart's improvements should pay off in stronger market share long-term.
PetSmart has been banged up a bit, sort of like the homeless pets that the company's charitable operations help place with families. The company didn't deliver the expected second-quarter earnings that Wall Street expected last summer, largely because of a partial collapse of the racks that store goods at the company's main distribution center in Phoenix. Meanwhile, the company told analysts that it probably wouldn't meet earnings expectations for 2006 either (the fiscal year ends January '07), mostly because of the infrastructure spending planned for the second half. The company had been suggesting that earnings of $1.37 to $1.39 a share were likely, and then later, $1.30 to $1.33 a share. (Analysts on average now expect $1.31 a share for the fiscal year ending this January and $1.56 a share for the year ending January 2008.) Though several analysts lowered their earnings estimates this summer, and some their price targets, recommendations all remained bullish.
That's partly because PetSmart doesn't command purebred prices. The stock is down slightly from a 52-week high last spring of nearly $30. And relative to estimated earnings, the stock is trading at a 7% discount to its five-year historical average. Though PetSmart isn't on the block, the premium price paid for Petco -- roughly equivalent to the stock's 52-week high -- bodes well for PetSmart.
Finally, as dogs go, you could say PetSmart has good bones and teeth. The company should be able to add 90 to 100 stores a year for at least six or seven more years. Pet services (grooming, training, boarding and day camp) could log 20%-plus revenue growth this year and next, while increasing customer loyalty. The stock should remain resilient even if consumers feel pinched, since 39% of company sales come from the dependable categories of food, treats and litter. Plus, history shows that PetSmart's sales are likely to bump up as gas prices moderate.
So pardon our analogizing, but long-term, we think investors will find PetSmart stock to be a loyal and worthy companion.