PetSmarts' Pullback Represents A Rare Opportunity

PetSmart has shown immense weakness over the last few months, but appears to be a great value play right now especially when compared to competitors in the online space Amazon.com and PetMed Express.

Jan 21, 2014 at 9:30PM

With the market nearing fresh all-time highs, it is not always easy to find new investments and the search can be frustrating. However, sometimes the market provides pullbacks in certain stocks while the rest of the industry rallies on or trades sideways. This is exactly what has happened in the United States' largest pet retailer, so let's see if we should be buying right now.

The pet supermarket                                                                                                                                                                           PetSmart (NASDAQ:PETM) is the largest specialty retailer of pet products, services, and solutions. It currently operates 1,314 stores in the United States, Canada, and Puerto Rico that carry all the pet products you need, and its stores also offer 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.

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Source: Motley Fool

Negativity sets it
The decline in PetSmart's stock came the day after it reached its 52-week high of $77.32 on Oct. 1. What started as a few down trading days turned into an accelerated decline when PetSmart cut its third-quarter outlook on Oct. 17. Third-quarter results were released on Nov. 22, which met expectations, but then the company proceeded to cut its fourth-quarter guidance and called for both earnings and revenue to decline year-over-year. Needless to say, the stock's fall continued.

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Is it inexpensive or dangerous?
Today, PetSmart is over 17.5% below its 52-week high and it has fallen more than 11% in 2014 alone. With this said, it trades at just 16.1 times its trailing EPS of $3.99 and 14.4 times 2014's full-year EPS estimate of $4.48; according to YCharts, the company's stock has a five-year average price-to-earnings multiple of 18.9, which means it is very inexpensive at current levels.

I believe the negative releases by the company will hinder its average multiple going forward, but PetSmart could still command a fair multiple of around 18. A multiple of 18 would price the stock upwards of $80 by the conclusion of 2014, representing growth of over 25% from today's level. On top of price appreciation, PetSmart will return additional capital to shareholders via its 1.2% dividend and the repurchase of common stock.

Competitors feeling the love
PetMed Express (NASDAQ:PETS) and Amazon (NASDAQ:AMZN) are two of the largest competitors to PetSmart. Both are operate entirely as e-commerce sites, so these are good places to shop if you already know what you are looking for. With this said, I think being a brick-and-mortar retailer gives PetSmart the competitive edge in terms of consumer trust; this is because pet owners are more apt to buy products within a physical location, rather than buying online, due to several issues with foreign made products causing illness and death in animals. PetMed Express is a very reliable source, but as a pet owner, I am still freaked out by the idea of ordering medicine on the Internet.

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Source: PetSmart

In addition to the trust-factor, PetSmart is the top player in the industry because if offers in-store services to its customers. In its third quarter, sales from grooming, boarding within PetsHotels, training, Doggie Day Camps, and other services rose 5.2% to $184 million. In the conference call, CEO David Lenhardt had this to say:

In services, sales growth of 5.2% in the third quarter outperformed the core, driven by strength in both Grooming and PetsHotels. We've built out a portfolio of add-on packages and upgrades, including customizable and seasonal packages with tie-ins to key exclusive brands that really resonate with our pet parents.

PetSmart is the clear cut, top-dog in this industry. We want to invest in the companies who offer everything consumers want or desire under one roof and that is exactly what PetSmart does. PetMed Express and Amazon are great companies, but when it comes to the pet product and service industry, look no further than PetSmart.

The Foolish bottom line
PetSmart is a great American company that is here to stay. Whether the company can deliver on fourth-quarter expectations remains to be seen, but I am confident that Americans will spend more on their pets in 2014 than ever before and this will strongly benefit the company. Investors should consider initiating a position on any further weakness and adding to it if it continues to fall.

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Joseph Solitro has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and PetSmart. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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