Profiting From Pets

At noon, America's largest pet pharmacy, PetMedExpress (Nasdaq: PETS  ) is up 16.16% on strong third-quarter results. Revenue increased 25% year over year, and net income roared ahead 37%. Both numbers topped the high end of estimates from the four analysts that follow the company.

PetMed is a small cap that offers approximately 750 of the most popular pet medications and health products for dogs, cats, and horses. PetMed markets its products via television, the Web, direct mail, and print advertising. These campaigns direct customers to the company's website or its toll-free telephone number. In the latest quarter, 57% of orders came through the company's website, which may represent a favorable overall trend for the company. Incremental costs scale much better on the Web than in telephone sales, and human capital costs are accordingly lower.

The good news is that PetMed is becoming increasingly profitable. This business is different from human prescription-provider (Nasdaq: DSCM  ) , where continued sales growth has yet to produce consistent profitability. Net income this year at PetMed is expected to be more than three times what it was for the fiscal year that ended March 2003. For the first nine months of this year, net cash provided by operating activities has nearly tripled year over year. Speaking of cash, the company boasts zero debt and a sizable $26.6 million in cash.

There is enormous growth potential for PetMed Express, which is expected (by analysts) to have sales of $135.3 million this year (with about 30% in prescription medications). In 2004, the American Pet Products Manufacturers estimated the U.S. pet medication market at $3 billion, with pet supplies at an additional $5.1 billion.

Being the No.1 pet pharmacy doesn't mean the company has reached mass-merchandising economies of scale. Historically, all the major pharmaceutical manufacturers have declined to sell prescription and non-prescription drugs to PetMed. If the company can establish a direct relationship with manufacturers, it will gain a price advantage on its competition.

The pet-supply market has specialty retailers like Petco (Nasdaq: PETC  ) and Motley Fool Stock Advisor recommendation PetSmart (Nasdaq: PETM  ) , as well as mass-merchandisers like Target (NYSE: TGT  ) . While that's formidable competition, customers ordering medications on PetMed are only a click away from adding a treat or a toy to their order. Convenience is a luxury that PetMed is ideally situated to provide.

PetMed Express is trading for 29.5 times expected earnings for the fiscal year ending March 2007. That sounds rich, until you realize that analysts expect the company to compound earnings at 35% a year for the next five years. That, in this observer's opinion, is hardly a heady premium for a small company with a No. 1 position in its marketplace and a rock-solid balance sheet.

Are you looking for great small-cap companies primed for powerful growth? Let theMotley Fool Hidden Gemsnewsletter bring you two small-cap selections to consider each month. Sign up today for a 30-day free trial.

Fool contributor W.D. Crotty does not own any shares in the companies mentioned. Assisting W.D. today was Minnie, a teacup poodle, who likes to man the office carpet while her supplier of toys and pet medications earns a living. Clickhereto see the Motley Fool's disclosure policy.

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