When I first read Monday's Associated Press story on the steep drop in Motley Fool Stock Advisor selection PetSmart (NASDAQ:PETM) shares, I thought investors' reaction to the analyst report was overblown. However, having taken some time to review and compare the two companies, I'm no longer so sure.

The AP article centered on an analyst downgrade on concerns that competitor Petco (NASDAQ:PETC) is lowering its prices to attract customers. The article quotes a portion of the analyst report as stating that Petco's prices are an average 15% higher than PetSmart's. With the price decrease, Petco's prices will only be 10% higher, and analysts conclude that Petco's more competitive prices will be able to steal away some sales from PetSmart, hurting its profitability and margins.

I initially thought this was a bit silly, because PetSmart's prices will still be lower. But I soon realized that PetSmart's prices will only be lower on average. Taking a closer look at how these two stack up on some relevant metrics in their last fiscal year reveals that they're not too far apart operationally.

PetSmart

Petco

Gross Margin

31.3%

33.6%

EBIT Margin

8%

7.3%

Inventory Turns

7

7.6

Stores

826

779

Total Retail Sq Ft (millions)

19

11.3

Sales ($ millions)

3760.5

1996.1

Sales/Sq Ft ($/sqft)

197.6

177.3

Op Income/Sq Ft ($/sqft)

15.8

13
Data from Capital IQ, a Division of S&P

PetSmart certainly drives higher sales per square foot, but the two companies' margins and inventory turns aren't too different. While a small decrease in prices may lower Petco's margins initially, any volume it can take from PetSmart should slightly increase Petco's profitability, while more dramatically harming PetSmart's.

I do think there's some reason for concern here, though I think that PetSmart may be able to mitigate some of it with its customer loyalty program and the more efficient floorplans it's rolling out. The competitive dynamic between the two will worth watching over the next few quarters as comparable-store sales, earnings, and margins come under increased scrutiny. Hopefully, a long-term relationship like that of Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) will develop in this space -- but that remains to be seen.

PetSmart is a Motley Fool Stock Advisor pick, while Home Depot is a Motley Fool Inside Value pick. Take any of our Foolish newsletters for a free 30-day trial.

At the time of publication, Nathan Parmelee owned shares in PetSmart but had no financial interest in any of the other companies mentioned. The Motley Fool has an ironclad disclosure policy.