Does your pet suffer from heartworms, fleas, or allergies? Then chances are you have heard of PetMed Express (NASDAQ:PETS), a leading retailer of all things pet drugs, from tick powders to hairball chews. This company has served up investor catnip in the form of solid earnings growth, a strong return on equity, and a stock that is up 72% over the last five years. Trouble, however, has reared up on hind legs in the form of flat revenues and disappointing earnings. Does PETS have a solid moat to help it past this rash? Let's find out.
PetMeds is a nationwide pet pharmacy with a market cap of $467 million and 2018 sales of $274 million. The company sells pet medications -- both over-the-counter and prescription based -- to customers online and through its branded hotline, 1-800-PetMeds. The company has thousands of items available for sale, covering nearly every ailment your pet may suffer from.
Think of PetMeds this way: if you take Funyun to the vet for an oozy skin rash the vet might write a prescription. Deciding to save some money, you take it to PetMeds to have it filled and shipped. On average, prices at PetMeds are 10% to 15% below vet prices, according to the company.It is this convenience and pricing that has allowed PETS to deliver solid earnings growth and a return on equity of around 27% over the past 10 years.Return on equity measures how well a company invests your money. The higher the number, the better the return. Also, the company has zero long-term debt on the balance sheet.
Recent results, however, are causing investors to ask whether PETS will rollover and play dead ... permanently? Revenues were flat and earnings fell below expectations in PetMed's most recent quarter. Also, gross margins dropped by 400 basis points. to 32%.As a result, PetMeds stock price is down 52% from its 52 week high and now sells for about 11 times earnings.Think of this last number as the time it takes to get back investment dollars -- the lower the better.
So, what was the main culprit? Online Competition. PETS had to ramp up its discounts because its doggie drug competitors were doing the same, sapping away revenues from PETS and cutting into its margins.The question is, does PETS have a competitive advantage that will help it turn the tables and make it a long-term winner for investors?
Think of a stock's moat as its defense against others who want to sack the company's castle and take its profits. A business with a wide moat can protect its castle and profits and ensure good, long-term results for investors. For PETS we find that it has some strengths in brand name recognition (it has been building the name 1-800-PetMeds for about 20 years now), a pricing advantage over vets, and switching costs (it can be a royal pain to switch prescription fillers just as it can be a hassle to switch banks).However, it is in barriers to entry that we find PETS's biggest advantage.
Starting a pharmacy in the U.S. is not easy. One must jump through regulatory licensing hurdles in each and every state. This is no easy task, and it can take tons of time and money. This acts as a deterrent for anyone who wants to start a pet pharmacy. PETS, on the other hand, is licensed in every state. If the story ended here we would have one happy pooch. This dynamic, however, has gravely changed.
Drugs From the Amazon
How does one get into the pharmacy business without jumping through hoops in all 50 states?
Buy a pharmacy that is already licensed in all 50 states.
That is exactly what Amazon did in June of last year when it purchased PillPack, a small online pharmacy, for about $1 billion, giving the online behemoth the ability to sell pharmaceuticals in all 50 states. Interestingly, the license needed to sell human drugs is the same one that is needed to sell pet drugs in some states such as Kentucky. To make matters worse, brick and mortar pharmacies such as Walmart, Target, and Walgreens are already selling pet meds through their pharmacies ... and Walmart delivers! Also, when it comes to over-the-counter drugs, a quick search of three of PETS top sellers -- a dewormer, flea and tick treatment, and allergy medication -- reveals that both Amazon and Walmart carry similar products.
In other words, PetMeds competitive advantage may have rolled over and played dead permanently.
The glory days may be over for PETS. This hocker of heartworm medication has delivered strong, historic results, but it appears that its competitive advantage, barriers to entry, has the mange. Hearty competitors like Amazon and Walmart have stepped into pharmaceuticals in a major way, and Walmart already carries some of the same pet drugs. Although brand and switching costs also provide some defense, it may be just a matter of time before this dog should be set out to pasture.