Just one quarter ago, investors were snarling and baring their teeth at Petco
Sales rose 10% as reported, with same-store sales climbing by 2%. Profitability was not so sharp, though, and the company suffered a slip in both gross and operating margins on a pro forma basis. At the bottom line, earnings were either up a little bit, if you use reported numbers, or down a bit, if you use pro forma figures. Either way, I'd say it was a mediocre quarter.
I'll admit that I haven't been a big Petco fan. I believe that management isn't always completely forthright with investors, and I'm not 100% sold on the basic operating philosophy.
That said, it's tough to ignore a few basic facts. The company produces impressive operating margins for a large retailer. Management also delivers very solid returns on invested capital and assets. Furthermore, when I analyze discounted cash flows, even after applying my "I don't like you" discount, the stock still seems worthy of serious consideration.
Maybe it was true for the Highlander that in the end, there could be only one, but that doesn't seem to often be the case in retailing. Wal-Mart
Assuming that there's room for both -- and I think there is -- that presents an interesting dilemma for this Fool. PetSmart has inferior returns on capital relative to Petco -- in absolute terms, PetSmart is fine -- and both companies will probably grow at similar rates for the foreseeable future. To make it all the more fun, my cash flow valuation analysis suggests that they're both about equally undervalued.
So do you go for the company you like, even if some of the financial metrics are inferior, or do you hold your nose and go with the better returns on capital? Whether I buy one, both, or neither, it'll be interesting to follow this story as it develops over time.
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).