PetSmart Unleashes Mixed Results, Considers Alternatives That Could Include Sale

PetSmart is generating lackluster sales growth, and this is a major drawback for investors. On the other hand, management is implementing a wide variety of initiatives to enhance performance, and is even exploring the possibility of selling the business. Is it the right time to buy this underdog?

Aug 20, 2014 at 1:46PM

Petm Image

Source: PetSmart.

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PetSmart (NASDAQ:PETM) on Tuesday evening reported financial results for the second quarter of fiscal 2014. Although earnings came in above expectations, the company generated declining comparable-store sales, which is a big drawback for investors. On the other hand, management is implementing a wide array of initiatives to improve performance in the coming quarters. The company also announced Tuesday that it is exploring "strategic alternatives for the Company to maximize value for shareholders, including a possible sale of the Company." Let's look at PetSmart's latest earnings report and a few important takeaways for investors.

The numbers

Net sales during the quarter ended on Aug. 3 grew by an uninspiring 1.4% to $1.7 billion, in line with analysts' expectations compiled by Thomson Reuters. Comparable-store sales, which include online sales, declined by 0.5% versus the same quarter of last year, while comparable transactions fell 2.6%.

While service sales saw an annual increase of 4.7%, merchandise revenue increased only 0.8% during the quarter. Since merchandise sales account for 87% of total revenue, this category is being a considerable drag on growth.

 Metric1Q 20132Q 20133Q 20134Q 20131Q 20142Q 2014
Comps Sales Growth/Decline 3.5% 3.4% 2.7% 1.2% (0.6%) (0.5%)
Comps Transactions Growth/Decline 0.8% 1% 0.2% (1.8%) (2.2%) (2.6%)

Source: PetSmart financial reports.

PetSmart opened 12 net new stores during the quarter, ending the three-month period with a total of 1,352 units.

Gross margin declined to 29.8% of sales, versus 30.2% in the same period of 2013. Operating, general, and administrative expenses declined to $352 million from $359 million in the second quarter of last year. PetSmart also reduced its weighted average diluted share count by 4.6%.

Cost discipline and share buybacks allowed PetSmart to generate solid earnings growth during the quarter. Earnings per share came in at $0.98, a 10% increase from the year-ago quarter and better than the $0.94 per share forecast on average by Wall Street analysts, according to Thomson Reuters.

Management reaffirmed guidance for the full fiscal 2014 year. The company expects comparable-store sales to be relatively flat, while net sales growth is projected in the low single digits. PetSmart expects full-year earnings per share in the range of $4.29 to $4.39, versus $4.02 per share during fiscal 2013.

The future

PetSmart is implementing a series of initiatives to reinvigorate the business. The company has acquired Pet360, a family of pets-related e-commerce websites, digital media programs, and content sites. Considering that the online revolution is becoming a major disruptive force across different retail categories, it makes sense for the company to move in that direction.

PetSmart also announced a broad expense reduction program that will target all areas of the business, and management plans to provide more specific details about the agenda and its targets in the next quarter.

At the same, time PetSmart intends to reinvigorate growth via a series of initiatives including broadening its product offerings, expanding its proprietary and exclusive products and services, increasing focus on online and omnichannel sales, and developing a more personalized customer experience.

In addition, management said it is exploring a possible sale of the company, among other alternatives to enhance shareholder value. Shareholders such as investment firm Longview Asset Management and hedge fund Jana Partners having been calling PetSmart to explore a sale, and management said in the press release that it has been having "constructive conversations with a wide range of shareholders," so the company seems to be receptive to the idea.

PetSmart is not providing a timetable for the process, and management is not planning to make any comments until the process is complete, whatever the outcome.

Key takeaways

Cost-cutting and share buybacks can only go so far to sustain earnings growth, so the main game changer for investors in PetSmart is whether the company can accelerate sales growth. Initiatives such as an increased online focus, more proprietary products, and an increasingly personalized service seem well-intended. However, it's not easy to combine these strategies with aggressive cost reductions, and exploring the sale of the business could be a major distraction for management. Things are not getting worse for investors in PetSmart, but they are not getting much better, either.

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