After a successful reentry into the public market in 2021, the stock of Petco Health and Wellness (WOOF -3.20%) has been a "dog" so far in 2022. The stock is down 30% year to date and its problems were exacerbated last week when the company missed earnings estimates and lowered guidance, causing the stock to sell off.
While the market said "woof" to the results, here's why buying shares on the dip now could look like a genius move in the future.
There are more pets than ever
Believe it or not, there are more pets in the country than ever before. And this is a secular growth driver for a company like Petco. The American Society for the Prevention of Cruelty to Animals (ASPCA) estimates that 23 million Americans adopted pets during the pandemic. This gives Petco a larger potential base of long-term customers that could come back repeatedly for everything from pet food to grooming and healthcare.
While sales of companion animals like ferrets and birds fell by 9%, sales of consumables, grooming, and other services continued to rise by double digits, and this is likely the more important and sustainable growth driver of the overall business over the long term. Sales of consumables grew 12% year over year and 37% over a two-year time frame.
While people might not be as likely to start a new aquarium or buy a new ferret during an economic downturn, they still need to buy pet food for the pets that they already own and they will still come in to get their dog groomed or to get their cat the shots that it needs.
On the recent earnings call, CEO Ron Coughlin emphasized the defensiveness of the pet business, stating that while discretionary spending is challenged, consumables and services continue to grow. Coughlin continued: "The Pet category continues to grow. Our customer base continues to grow, and our unique competitive moats continue to deepen."
Although the stock fell in part based on slowing sales growth, the company is still growing sales, even during a challenging environment, for which it deserves some credit. While same-store sales growth was only 4%, on a two- and three-year basis, same-store sales growth is up 23% and 34%, respectively. The company says it added 325,000 new customers during the quarter, making it the 14th straight quarter that it grew its customer base.
Not just pet food
There is a lot more to Petco than just pet food. As mentioned above, the company also offers services like grooming, training, and even veterinary services. Petco's services segment grew by 13% year over year, but more impressively, they are up 62% over a two-year basis.
Offering these services is a smart way for Petco to utilize its physical locations to create a moat -- pet owners can't go to Chewy or Amazon to get their pet groomed or vaccinated. Furthermore, this dynamic creates the possibility that someone who goes in for other services may also see a toy or a treat that they like for their pet and make an impulse buy while they are there.
Is Petco a buy?
After the sell-off, shares of Petco now trade at 15 times forward earnings, which is slightly below the average multiple for the broader market. Petco also looks undervalued based on its price-to-sales ratio, trading at less than one times revenue. On this basis, Petco's valuation is less than half that of its more heralded rival, e-commerce pet supply business Chewy, even though Petco is profitable and Chewy is not.
Petco looks like it is using its physical footprint to build a long-term moat to bolster its defensive consumables business with services like veterinary, grooming, and training. After the sell-off, shares now look attractive from a valuation perspective and an investment in Petco on the dip will likely end up looking like a prudent move for long-term investors in the years ahead.