Three Pet-Care Stocks to Ride the Trend

Here's how you can cash in on Americans' increased spending on their furry friends.

A rising tide may lift all boats, but it's a classic investment mistake to assume it'll lift all stocks. Case in point: companies that cater to our growing passion for pets. Spending on pets in the U.S. is expected to hit $43.4 billion this year, up more than 5% from last year, according to the American Pet Products Manufacturers Association.

That is a powerful trend, and there are at least two companies that should let you cash in on it. But first, a note of caution. Three years ago, as the trend gathered fresh momentum, retailer PetSmart (symbol PETM) was a darling of analysts and the media. Then the stock took a dive. It peaked in May 2005 at about $33, then dropped to $21 in September of that year. The shares closed at $27.01 on September 12 of this year, up from a 52-week low of $18.75 on March 7. So although the stock has experienced dramatic ups and downs since 2005, long-term shareholders of PetSmart haven't ridden the pet wave anywhere.

That said, it looks like PetSmart is finally getting its act together. Despite the "softening retail environment," the company said recently that it expects to meet its financial targets and earn between $1.51 per share and $1.59 per share for the fiscal year that ends next January.

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Results for the second quarter, which ended August 3, looked weak, but only at first glance. PetSmart reported net income of $37.2 million, or 30 cents per share. That's down from $47.1 million, or 35 cents per share, in the same quarter of last year-but the earlier figures included a $6.7-million, one-time gain. The good news is that sales for the second quarter increased 11.2%, to $1.2 billion, from the year-earlier period and that comparable store sales (sales at stores open at least a year) were up a healthy 4%.

The company plans to slow the opening of new stores and concentrate on profitability, which could finally get the stock price on a sustained climb. Based on the upper end of PetSmart's fiscal-year forecast, the stock sells at 17 times earnings.

PetSmart has potential, but I think the more-dependable pet plays are companies that provide veterinary products. I have a standard-issue golden retriever. Given that times are tight, I, like many dog owners, have put off buying her the occasional squeaky toy and have even switched to a cheaper brand of dog food. This doesn't bode well for the likes of PetSmart. But despite Rosie's many neuroses, I've grown fond of her and wouldn't spare any expense when it comes to her medical care.

And that brings me to Animal Health International (AHII). The company supplies more than 40,000 products -- including pet food, drugs and equipment -- to more than 65,000 veterinarians, retailers and farmers. Yes, farmers. The bulk of the company's sales are for animals we milk and eat, not ones we name and take for walks.

However, 40% of the company's sales come from pet-related products, so this can still be considered a legitimate pet play. Still, sales to the livestock industry have been a drag. High grain prices have squeezed farmers' profit margins, and they've responded by reducing herds and spending less on Animal Health's products. The stock, which was as high as $15 in July 2007, closed at $7.83 on September 12.

But prospects for a stronger beef market are bullish for the stock. Beef cattle account for about one-third of Animal Health's sales, says Piper Jaffray analyst Mark Arnold. Grain prices are stabilizing, and activity in the futures market foreshadows higher cattle prices over the next six to 12 months, he says. This should spur farmers to raise more cows and buy more Animal Health products.

Meanwhile, the pet portion of the business continues to track national trends. The Westlake, Tex., company posted a 14% increase in sales for the fiscal year that ended in June, and says it expects sales to rise 3% to 9% in the June 2009 year. Analysts forecast profits of 66 cents a share for the year, up from 46 cents in the June 2008 year.

Getting back to Rosie. She insists that I take her for long walks in the woods, where she is a tick magnet. Tick-control medicine from pet stores and vets can get pricey. That's why we order our stuff from 1-800-PetMeds, which is run by PetMed Express (PETS).

PetMed Express is basically a pharmacy that sells products for dogs, cats and horses directly to consumers. You can buy popular pet products such as Frontline Plus, K9 Advantix and Heartgard Plus. I've told other pet owners about PetMed, and they have responded enthusiastically to the convenience and prices.

The company is growing like a puppy on steroids. Analysts figure it will produce sales of $238 million in the fiscal year that ends next March, up from $216 million in the March '08 year. Earnings per share should rise to 88 cents a share in fiscal '09 from 81 cents. At $15.86, the stock sells at 18 times fiscal '09 estimates, a reasonable price-earnings ratio for a company that analysts think can generate earnings growth of 18% a year over the next few years.

Bob Frick
Senior Editor, Kiplinger's Personal Finance