PetSmart: Beware of the Dog?

By Alyce Lomax | More Articles
May 28, 2008 | Comments (2)

Shouldn't PetSmart (Nasdaq: PETM ) be in the doghouse after last week's quarterly results?

Its first-quarter profit actually dropped a whopping 61.4% to $41.2 million, or $0.32 per share. Of course, you may recall that last year's first quarter included a mammoth $0.47-per-share gain from PetSmart's transaction related to MMI Holdings.

PetSmart's sales increased 9.1% to $1.2 billion, with comp sales growing 2.9%. Operating income did rise by 4.8% to $80.3 million. And PetSmart touted the strength of its pet services segment, where sales surged 21.6% to $130.4 million.

I get why many people love PetSmart. Americans adore their pets and will go to great lengths for them. However, I have had a hard time feeling very bullish on PetSmart for a while now (my PetSmart pessimism started last November). And now, with consumer confidence at a 16-year low, I just can't get behind this stock.

After all, people can get all manner of pet supplies at Wal-Mart (NYSE: WMT ) , Costco (Nasdaq: COST ) , or Target (NYSE: TGT ) . If they want convenience, there's an array of choices at their local Safeway (NYSE: SWY ) , and even Whole Foods Market (Nasdaq: WFMI ) has organic pet chow. Plus, how many extra trips do folks want to make these days? The options I name above are all pretty much one-stop shops, and that's mighty helpful when gas is hovering around $4 a gallon.

Let's not forget that many people may remain loyal to mom-and-pop pet shops that provide specialty items big chains don't carry (and which often offer an extremely personal touch).

PetSmart's services, like pet hotels, grooming, and training, are indeed pure high-margin genius. However, they're much more genius when the economy's booming. Travel is likely to be greatly curtailed until consumers feel better about their pocketbooks, and even if they do travel, I'd imagine they might be more likely to rely on family or friends to watch their furry buddies while they're away. And if Mommy decides not to get her own hair trimmed as regularly, is Fifi's coiffure going to be seen as a priority? I'm not entirely convinced.

It's always been perfectly reasonable to wonder how much PetSmart could grow when it has tons of competition. Now, though, with consumers putting themselves on tighter leashes budget-wise, I'm concerned that this stock may need an ominous sign: "Beware of the dog."

Related Foolishness:

In March, PetSmart needed a scooper.
PetSmart was unleashed in November, but I wasn't convinced.
Check out PetSmart's big ouch in January.

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PetSmart is a Motley Fool Stock Advisor recommendation, as are Costco and Whole Foods Market. Wal-Mart is a Motley Fool Inside Value pick.

Alyce Lomax owns shares of Whole Foods Market. The Fool's disclosure policy's not a dog -- well on second thought, maybe a cute, friendly one.

Read/Post Comments (2) | Recommend This Article (8)

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Report this Comment On May 29, 2008, at 9:04 AM, sddingman wrote:

I have to disagree with the assesment of where people shop vs. PetsMart.
First, Wal-Mart does not have the quality and selection that PetsMart has, they will only carry the basics for people too lazy to shop elsewhere. And by the way Wal-Marts prices on pet items are no lower than competitors (PETM) or mom-and pops on average.
Second, PetsMart is in more locations in my area than Wal-Mart(which I personally hope stays that way),
Third PM has a good touch of helping local shelters adopt animals and they help other animal related charities in our area. A community touch that the evil empire lacks and will never have.
I like Mom and pop shops well enough, but unless Americans in general readjust the way we live, I do not see them holding on much past the 2010's.
PetsMart will thrive if they can offer a good service, and covienent locations. If Ms. Lomax's only objection is that PetsMart will not do good because of Wal-mart, then I have to meow in disagreement.
Report this Comment On May 29, 2008, at 9:40 AM, fundamntl wrote:

You start off citing the profitability of the company (in a funky economy) but then appear to be bearish on the good financial performance (by any objective measure) based on what appears to be a gut feel.
The Wal-Marts and Targets are not direct competition. Generally PetSmart has in my experience been located near one of these other big box retailers and price differences are generally negligible for the same or comparable items. So the extra driving argument seems moot...you're practically there already.
With a range of price competitive items and also items unique to PetSmart I don't see the other retailers as serious competition. PetSmart has one feature the competitors you mentioned do not ....you can take your pet into PetSmart. Don't underestimate the power of this. There are few major stores in the US where Fido or Fluffy are welcome, and pet owners are often looking for an excuse to take their pets someplace with them. It sounds frivolous, but believe me it's a powerful attractor for pet owners.
The mom and pop chains have their place, but have always been so. However, in many of the communities I've lived in, there is no mom and pop alternative. PetSmart or PetCo are THE pet stores in the area. Frankly the market is large enough that the mom and pop and niche stores can and do have a symbiotic relationship with the larger PetSmart.
I agree that services like hotels, grooming and training could take a hit in a downward economy. However the argument that folks are more likely to leave their pets with friends or family doesn't hold water. The target market for pet boarding services would seem to be the folks who don't already have friends or family they can rely on to watch a pet. Given a choice, I'm pretty certain most pet owners would rather rely on trusted family or friends to care for their furry kids. The people who use boarding services are not likely to stop doing so, unless it's because they have chosen not to travel at all.
As for grooming, if you have a pet that needs regular grooming, you will continue to do so although maybe not as frequently (maybe every 6 weeks instead of 4). I imagine that some will try the do it yourself approach, but frankly many folks aren't prepared to cut their dogs hair or trim their nails. Speaking as one who balked at grooming fees higher than my own haircuts, I tried the do it yourself approach. Twice was all I could handle before deciding that maybe paying a professional was worth the expense. (And I generally consider myself a handy guy - repair my own appliances, tune up my own car, etc.) I've known many others who came to the same conclusion.
People often wonder about how PetSmart will grow, but they have consistently met all challenges and found ways to profitably grow the company over the long term. As you pointed out, they did grow year over year in a rough economy. They've consistently turned a profit, they have a strong balance sheet, and they still pay dividends. Their management has proven adaptable and has given me no reason to believe that they are out of ideas on how to weather the current challenges. To the naysayers, PetSmart has simply tapped a market that either you get or you don't. Those of us who "get it" see any price erosion now as a long term buying opportunity.
People won't stop owning pets, and they will continue to want to treat them well. As long as that's the case, PetSmart should be able to figure out how to make a profit.
I say this dog will hunt for years to come.

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