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5 Top Stocks to Own in 2014: PetSmart

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In the final part of this five-article series, we will look at the largest retailer of pet products and solutions, PetSmart (NASDAQ: PETM.DL  ) . It has underperformed the market in 2013, rising just over 5% as the S&P 500 has returned well over 25%, but I do not believe this trend will continue in 2014. Let's take a look at what could drive PetSmart's earnings much higher next year and why we should be buying it right now.

The pet superstore
PetSmart is the largest specialty retailer of pet products, services, and solutions. It currently has 1,314 stores in the United States, Canada, and Puerto Rico. These stores carry all the pet products you need, along with grooming, training, adoption services, and Doggie Day Camps. PetSmart also operates 196 PetsHotels and it has Banfield Pet Hospitals connected to over 60% of its locations.

A year of under-performance
2013 did not provide much of a return for PetSmart's stock, as it rose just 5.34% as the S&P 500 rose 25.87%. Earnings have shown strong growth, but revenue has been light and it will only rise about 3% on the year; this is because comparable-store sales have been weaker-than-expected and they will rise between 3%-3.5% for the year. Here's a look at PetSmart's four earnings reports released in 2013 and a chart of the stock's run year-to-date:

Quarter 4Q '12 1Q '13 2Q '13 3Q '13
Earnings Growth 36% 15% 25% 17.3%
Revenue Growth 15% 5% 5.3% 4%
Comp-Store Sales +4.6% +3.5% +3.4% +2.7%

The year ahead
In the fourth quarter, PetSmart expects to earn $1.19-$1.23 per share, in-line with analyst estimates, and this would place full-year earnings in the range of $3.94-$3.98. For the full year of 2014, analysts currently expect PetSmart to earn $4.50 per share, an increase of 13.1%-14.2% from 2013. I believe PetSmart's 2013 earnings and the expectations for 2014 would support a run higher than the overall market's return.

Additional shareholder returns
In addition to earnings growth, PetSmart also pays a healthy dividend and it is in the middle of a share repurchase program. The dividend was raised 18% in September to $0.195, putting PetSmart's yield at about 1.07%. This is the fifth consecutive year that PetSmart's dividend has been raised and I believe this streak will continue in 2014 due to the company's ample free cash flow.

On Sep. 26, PetSmart's board of directors authorized a $535 million share repurchase program. The repurchasing began on Oct. 1 and it will be completed by Jan. 31, 2015. Management stated, "today's announcement reaffirms our commitment to returning excess cash to our shareholders through a combination of dividends and share repurchases." This shows PetSmart's dedication to its shareholders which is exactly what we look for when placing an investment.

A fresh brand to boost sales
Pet owners get very excited when trusted brands come out with lines of pet products and this was exactly the case when Burt's Bees, the loved brand owned by Clorox (NYSE: CLX  ) , came out with Burt's Bees Natural Pet Care.

Burt's Bees showed tremendous double-digit growth in Clorox's latest earnings report, a much needed boost for a slow-growth company. I believe the Burt's Bees line of pet products will be the fastest-growing brand since GNC (NYSE: GNC  ) partnered with PetSmart to create GNC Pets. GNC Pets is a line of premium vitamins and supplements for dogs and cats that came to PetSmart stores in the fall of 2010. GNC does not provide specifics about the earnings of its pet line, but the segment that includes this line has posted revenue growth of 10.3% in the first nine months of 2013. I believe new brands like Burt's Bees and the existing line of GNC products will keep PetSmart's sales on the rise.

Americans love their pets
Another bullish indicator for PetSmart is the American Pet Products Association's estimate that $55.53 billion will be spent on pets in 2013 and this number could easily surpass $58 billion in 2014. As the largest provider of pet products in America, PetSmart will continue to benefit from this growth, especially when it is home to the most in-demand brands. Take a look at total pet expenditures since the beginning of 2009:

Year 2009 2010 2011 2012 2013
Pet Expenditures $45.5B $48.35B $50.96B $53.33B $55.53B (est.)

Where could it go?
Today, PetSmart trades at about 18.3 times 2013's earnings expectations of $3.98 and 16.2 times 2014 earnings estimates of $4.50. According to YCharts, PetSmart's five-year average price-to-earnings ratio is 18.9 and I believe it could trade at a fair multiple of 18.5 next year; this fair multiple could put PetSmart's share price upwards of $83.25, an increase of 14.2% from current levels. I believe an increase of over 14% would suffice to outperform the S&P 500 in 2014 and the company will provide even higher returns via its dividend and share repurchases.

The Foolish bottom line
PetSmart is a great American company and it is the largest player in the pet products and services industry. It will continue to benefit from the growing industry, the addition of new brands, and consistent store expansion. I believe PetSmart will outperform the overall market in 2014 and it will more than make up for its under-performance in 2013. Keep a close eye on this one and consider adding it to your portfolio.

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