I mentioned in passing yesterday that leading pet retailer and Motley Fool Stock Advisor pick PetSmart (NASDAQ:PETM) lowered its earnings guidance. Let's take a quick look at that guidance cut and recount what PetSmart told investors at its Investor Day event yesterday.
Like a number of other retailers, PetSmart is citing hurricanes Katrina and Rita, in addition to the increasing cost of energy, as the main reasons for cutting its earnings estimates. The company moves down its diluted earnings guidance from $0.21 per share to $0.18-$0.19 for the third quarter (ending Oct. 31) and from $1.25-$1.26 for the year to $1.16-$1.20. The lowered guidance for the year still puts PetSmart on track to deliver diluted annual earnings growth per share of between 1.8% and 5.3%.
The cut in guidance does sound a bit like an excuse, but I'm willing to give PetSmart the benefit of the doubt. Sure, not all companies are currently lowering guidance, as PetSmart just did. However, it's not abnormal for consumers to slow down spending and reassess their financial position when faced with increased costs for necessities such as fuel. Taking care of pets remains a necessity for many people, and so I believe PetSmart when it says that the slowdown of its sales and earnings growth is only temporary.
It will also be interesting to see how competitor Petco (NASDAQ:PETC) does in its third quarter, considering that the company has already lowered its guidance.
Along with PetSmart's announcement of lowered guidance, the company also held an Investor Day yesterday. At the event, the company discussed its decision to change its branding logo from PETsMART to PetSmart (emphasizing "smart" over "mart") and the associated advertising campaign. Management also reiterated the long-term potential of its PetsHotel and Doggie Day Camp kennel services, as well as its PetPerks savings card.
PetSmart expects that it can eventually roll out 300 joint PetsHotels and Day Camp facilities in its U.S. stores. The company believes that these facilities can increase the pre-tax profitability of each store by 93% by way of the earnings potential of providing boarding, training, grooming, and food services to pets.
PetSmart also believes it can grow earnings per share by 20% annually over the long term. I'm not going to say PetSmart can't grow that fast, but when I bought shares a few weeks ago, I wasn't willing to base my valuation on 20% growth. Instead, I went with growth of 12% for the first five years, 8% for the next five, and 3% thereafter. With those more conservative assumptions, my analysis showed PETM shares still trading at a 25% discount to their fair market value. And that's before the dividend, which I expect will grow over time. If management can hit my conservative growth targets, the stock should rise from current levels, and any additional growth would be gravy. However, caution is warranted until management proves that the current traffic slowdown in its stores is temporary.
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Nathan Parmelee owns shares of PetSmart but has no financial interest in any of the other companies mentioned. The Motley Fool has an ironclad disclosure policy.
