PetSmart's Living a Dog's Life

A recent Wall Street Journal article noted that singer Fiona Apple canceled a concert to be with her dying dog. While the move elicited a few catcalls of "It's just a dog," the overwhelming tenor of the commentary was one of support. Most of us know the pain of loss in having one of our pets pass or having to euthanize it; it's just that most of us don't get to take a week off to deal with it.

Caring for our pets has become big business, with "pet parents" spending almost $53 billion annually on food, products, and services. Pet products supplier PetSmart (Nasdaq: PETM  ) has identified the trend's growth with the "humanization" of Spot and Fluffy. As affluence has changed attitudes, they're no longer just dogs and cats, but rather "pet babies."

A nation of pet lovers
According to the American Pet Products Association, 62% of all U.S. households -- some 73 million homes -- own a pet: 46 million own a dog, 39 million own a cat, 12 million own a fish, 4.6 million own a reptile! That's only slightly less than the 5.7 million that own a bird, but almost twice as many as own a horse.

I'll admit to chafing at this movement to humanize animals, siding more with those who commented on Fiona Apple's Facebook page that "it's just a dog," but I can't argue with the profits it generates. PetSmart is enjoying a period of expanding margins that hit levels not seen since the recession. Last quarter, earnings surged 46% from the year-ago period on a 9% increase in revenues that grew to $1.6 billion.

As the largest pure play in publicly traded pet-care companies, PetSmart has ridden the trend higher. Its stock has surged 50% over the last 12 months, better than the 13% rise in the S&P 500, driven primarily by the increased sales in the consumables category.

Chow time!
Food, in general, comprises half of the industry's annual sales,  and the super premium category is PetSmart's fastest growing segment. The excess profit is attracting competitive attention, with even Wal-Mart (NYSE: WMT  ) entering the fray, recently unveiling its private-label Pure Balance brand.

Grown from the pet-food recalls of 2007, consumers have been looking for better, more natural foods for their pets, leading Nestle to invest more in its Purina One Beyond, Colgate-Palmolive (NYSE: CL  ) to reformulate its Hill's Science Diet as a natural product, and Procter & Gamble's (NYSE: PG  ) to offer up its Natura line.

The biggest threat to PetSmart's dominance might be the online arena, where more than $2 billion is spent annually, $666 million of which is spent on pet food. Privately held Petco is the leader here, with a 1.7% share of the online market, followed by Wal-Mart at 1%. PetSmart comes in third at 0.9%. 

Amazon.com (Nasdaq: AMZN  ) bought Quidsi last year and launched Wag.com, which offers more than 15,000 products with free shipping for its Prime members, while PetMed Express (Nasdaq: PETS  ) is the largest virtual pet store, with an 8% overall share of the market, but that obviously includes therapeutic products as well. The battle for mind share online led PetSmart to revamp its own website and offer 8,000 products that weren't found in its stores.

Where PetSmart should continue to lead is in services, which grew 8.5% in the third quarter to $175 million, still only a small portion of its total revenues. While grooming services were the leading category, improved occupancy in its PetsHotel also contributed to the growth.

Celebrate life
As we're in the midst of the Christmas shopping season, PetSmart expects owners to spend some $5 billion over the holidays on food, hard goods, and gifts, with 76% of them buying their "pet babies" a gift. We might not be able to take an extended vacation like Fiona Apple when it comes to the end of our pet's life, but at least we can celebrate the holidays with them while they're still here among us.

Investors might want to celebrate with a bit of PetSmart stock. At 21 times earnings and 18 times estimates, it might appear a little richly valued, but with an enterprise value of trading at 16 times its free cash flow, the pet-products supplier is a decent value, though certainly no dog.

Wagging the tail
Everyone knows Amazon is the big bad wolf in the retail world right now, but at its sky-high valuation, most investors are worried it's the company's share price that will get knocked down instead of its competitors'. We'll tell you what's driving the company's growth, and how to know when to buy and sell Amazon, in our new premium report. Our report also has you covered with a full year of free analyst updates to keep you informed as the company's story changes, so click here now to read more.


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