Do Pet Products Provide Premier Profitability?

Because consumers' persistent caution on spending does not extend as much to their pets, PetSmart, PetMed Express, and Zoetis are all reporting increasing sales.

Feb 8, 2014 at 7:00AM

Although the consumer products market has improved substantially since the recession was in full force, many manufacturers and retailers of consumer products still refer to the current conditions as challenging and the consumer as cautious. One sector that suffered less during the lean years of 2008-2011 was pet products. According to data from the American Pet Products Association, total U.S. pet industry expenditures were $43.2 billion in 2008 and an estimated $55.53 billion in 2013 -- this is an increase of nearly 29% over that time-frame.

That's why today we'll look at PetSmart (NASDAQ:PETM), PetMed Express (NASDAQ:PETS), and the exotic-sounding Zoetis (NYSE:ZTS) -- a company that makes medications for livestock and companion animals.

Noting wrong with steady greatness
PetSmart, which began a quarter-century ago as a small retailer of pet food in Phoenix, Arizona, is now the leading specialty pet products retailer in the United States with over 1,300 locations. The company's business model has evolved into providing services as well, as it offers pet boarding, grooming, and veterinary care through Banfield Pet Hospital locations in its stores.

For the third quarter of 2013, the company reported that total sales were up 4% from the year-ago quarter to $1.7 billion. Sales of services, which the company includes in total sales, rose by even more at 5.2%. Comparable-store sales were up 2.7%. In its guidance, PetSmart said that it expected even higher full-year comparable-store sales growth of 3%-3.5%.

What's striking about PetSmart's quarterly and year-to-date numbers is consistency. Sales for the first three quarters, for example, were up 4.6%. Cost of sales as a percentage of sales declined by 20 basis points for both the quarter and the first nine months. Operating, general and administrative expenses declined by 20 basis points for the quarter and 30 basis points year-to-date.

As CEO David Lenhardt commented in the earnings release, "Our performance demonstrates the strength and stability of our business."

If we need further confirmation of his statement about strength we only have to look at PetSmart's net income, which increased a fine 12% in the third quarter year-over-year to $92 million.

An OK quarter in a solid year
PetMed Express features a direct-to-consumer distribution model driven by its website -- responsible for approximately 80% of sales -- and its familiar phone number, 1-800-PETMEDS. Many pet owners buy medications on a recurring basis, so the PetMeds model saves them the time required to travel to the store when they need to reorder a medication.

For PetMed's third quarter ending Dec. 31, the company reported net sales of just over $50 million for a small increase of 1% over the same quarter last year. For the first nine months, the sales increase was more exciting at 4.6%.

The company focuses, and rightly so, on the pace of reorder sales because little marketing effort and expense is required in comparison with what it takes to attract new customers. Reorder sales were up 3.6% in the third quarter.

Income from operations actually declined 2.2% year-over-year due to an approximately 100 basis point drop in gross profit percentage. The company's ability to control costs was demonstrated by general and administrative expenses decreasing slightly from 2012's third quarter. Advertising expenses declined almost 2% as well.

PetMed's year-to-date profitability was much better than it was for the quarter, with a nearly 7% increase in income from operations. 

Helping the swine, the bovine and the canine
Zoetis was the former animal health segment of mammoth pharmaceutical company Pfizer which became independent last June 24. In its niche of animal care products, Zoetis is mammoth as well, with revenue of $1.1 billion in the third quarter alone. These sales represented an 8% increase from the third quarter of 2012.

Zoetis is a global company, and each of its four regions reported excellent revenue growth in the third quarter. The U.S., which accounted for 45% of total revenue for the company, reported a revenue increase of 10% over the year-ago quarter. Of particular note was the 10% increase in companion animal product sales.

Revenue in the second-largest region, Europe/Africa/Middle East, was up 9% with companion animal product sales up 15%. The Canada/Latin American region achieved a 9% sales increase as well, and the Asia/Pacific region grew its sales by 7%.   

Cost of sales for Zoetis increased only 7% during the quarter. However, a 19% or $64 million jump in selling, general, and administrative expenses caused Zoetis' net income to drop 19% year-over-year from $162 million to $131 million. The company has made investments to build out its own infrastructure as a stand-alone company, which are reflected in these higher expenses.

What we learned
PetMed Express's performance this year has been admirable particularly in light of the fact that net sales decreased 4.4 percent last year from the previous year. The keys to the company's future growth will be stepping up its acquisition of new customers as well as building its reorder sales. Product offerings expansion is one way the company will attempt to accomplish this objective.

PetSmart's pace of store development slowed in the first nine months of 2013 in comparison with the previous year. In the third quarter, it opened 16 new stores versus 24 in the third quarter of 2012. Through three quarters, 41 new PetSmarts opened their doors versus 49 in that period of the previous year.

PetSmart is taking a balanced strategic approach by striving to increase the performance of its existing stores while it opens new ones at a steady, but not spectacular, pace. That way, total revenue benefits from increases in same-store sales and sales from new locations.

Zoetis' ability to grow its sales -- significantly -- across the globe is a foundation for continued success. I like the fact that its product line addresses the global need for safer food supplies of meat and poultry. It's important to keep in mind that although this company is new to the public markets, it is not just a spunky up-and-comer. It has already arrived as the leading animal health company.    

Long-term investors should continue to find PetSmart attractive, and I like Zoetis as well.   

Pet care isn't the only area for great growth
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Brian Hill has no position in any stocks mentioned. The Motley Fool recommends PetSmart. 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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