PetSmart: Mixed Earnings and Reduced Outlook Have Sent Shares Lower; Is This an Opportunity to Buy?

PetSmart (NASDAQ: PETM  ) , the largest specialty retailer of pet products and services in North America, has just announced its earnings for the first quarter of fiscal 2014 and the stock has reacted by making a sharp move lower. Let's break down the quarter and the company's outlook on the rest of the year and then compare it to a competitor, PetMed Express (NASDAQ: PETS  ) , to determine if this decline is our opportunity to buy or if we should avoid investing for the time being.

Source: PetSmart's Facebook

The results are in
PetSmart released its first-quarter report before the market opened on May 21 and the results were mixed compared to analysts' expectations; here's an overview:

Metric Reported Expected
Earnings Per Share $1.04 $1.02
Revenue $1.73 billion $1.77 billion

Source: Estimize

PetSmart's earnings per share increased 6.1% and revenue increased just 1.1% year-over-year, as comparable-store sales decreased 0.6%; here's a breakdown of the company's revenue by segment:

Segment Revenue Revenue Growth
Merchandise $1,519.01 million 0.6%
Services $200.16 million 3.5%
Other $9.97 million 3.4%

Source: PetSmart

PetSmart's gross profit increased 0.2% to $530.84 million and operating profit increased 2.5% to $171.76 million. In relation, the gross margin contracted 30 basis points to 30.7% and the operating margin expanded 10 basis points to 9.9%; the company attributed the contraction of the gross margin to higher costs of merchandise and materials for its services, and the expansion of the operating margin was helped by a 0.9% decrease in operating, general, and administrative expenses.

Source: Wikimedia Commons

This performance led to approximately $137 million of free cash flow generated during the quarter and this, paired with ample cash on hand to start the quarter, allowed PetSmart to repurchase approximately $130 million worth of its common stock and pay $20 million in dividends. The company ended the quarter with over $301 million in cash and cash equivalents, so it is safe to assume that it will continue to repurchase its shares at a similar pace and maintain its $0.195 quarterly dividend going forward.

Also, seven new stores were opened during the quarter, bringing PetSmart's total count to 1,340 in the United States, Canada, and Puerto Rico. The company added that it opened one new PetSmart PetsHotel dog and cat boarding facility within one of these stores, bringing its total PetsHotel count to an even 200.

Overall, it was a quarter of little growth for PetSmart and the sentiment on the Street only got worse when the company went on to provide its updated full-year guidance...

What does PetSmart expect going forward?
As a result of the disappointing first-quarter results and its expectations for continued weakness for the remainder of 2014, PetSmart lowered its full-year outlook; here's what the company now expects to accomplish versus its previous outlook:

Metric Previous Outlook Current Outlook
Earnings Per Share $4.42-$4.54 $4.29-$4.39
Revenue Growth 4%-6% low single digits
Comp-Store Sales Growth 2%-4% relatively flat

Source: PetSmart

The new guidance calls for earnings-per-share growth of 6.7%-9.2% from fiscal 2013, which came in well below analysts' expectations of 10.7% growth and would end PetSmart's streak of consecutive years with double-digit earnings-per-share growth at four.

Source: PetSmart

PetSmart also said it expects second-quarter earnings per share in the range of $0.92-$0.96, which represents an increase of 3.4%-7.9% year-over-year, and "flat to slightly down" comparable-store sales growth; this too came in below the consensus analyst estimate, which projected earnings per share of $1.00.

The market reacted to the mixed earnings and reduced outlook by sending PetSmart's shares more than 10% lower over the next two trading sessions, setting a new 52-week low along the way. The stock now sits more than 25% below its 52-week high of $77.32, but I do not believe that this is an opportunity for investors to buy; in fact, I believe there is still more room to the downside due to PetSmart's weak outlook on the year and the high possibility of the company missing revenue estimates in an upcoming quarter. For these reasons, I would avoid placing an investment in PetSmart today and would simply monitor it going forward.

How has the competition fared?
PetMed Express, the online and over-the-phone retailer of pet medications and products, released quarterly earnings of its own on May 5 and it too watched its stock take a hit as a result; here's an overview of its fourth-quarter report:

Metric Reported Expected
Earnings Per Share $0.23 $0.22
Revenue $48.63 million $52.00 million

Source: Thomson Reuters

PetMed's earnings per share were flat and revenue decreased 4.9% compared to the same period a year ago. The company blamed "colder-than-normal weather" as a primary reason for the decline in revenue, but I find this very hard to believe given the fact that it conducts its business 100% online and over the phone.

Source: PetMed Express

PetMed's gross profit decreased 4.2% to $17.46 million, but the gross margin showed strength, expanding 20 basis points to 35.9%; this expansion resulted from a 4.9% decrease in advertising expenses and a 5.5% decrease in general and administrative expenses. 

The highlight of the quarter came when PetMed announced it would be maintaining its quarterly dividend of $0.17, which gives it a yield of about 5% at current levels. The dividend seems safe for the time being, but if the company continues on the path of negative sales growth, I would not be surprised if it were reduced or terminated completely. 

In summary, it was another disappointing quarter for PetMed Express and its shares responded by falling more than 3% over the next few trading sessions. The shares have since recovered from the decline, but I do not think there are any catalysts for the company going forward, so I would urge investors to avoid it indefinitely. 

The Foolish bottom line
PetSmart's disappointing first-quarter earnings results and reduced outlook on the year have sent its shares tumbling more than 10%. The stock now sits at a new 52-week low and yields about 1.4%, but I believe there is more room to the downside, so I would not be a buyer right now. Foolish investors should simply monitor PetSmart's stock going forward and wait for its next quarterly report or any positive news before reconsidering the possibility of an investment. 

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