Want to invest in a business where people will keep spending money, even during rough times? Try PetSmart (NASDAQ:PETM), a leading provider of pet products and services.
The company offers a variety of services, such as grooming, training, boarding, and even day camp (no, that's not a typo). PetSmart also sells food, furniture, and toys for all our animal friends, who are also welcome in the store. Based on my experience, workers are very knowledgeable and helpful. It is obvious the company invests time, money, and effort into training employees, because if your pet has a need, the company wants to fulfill it. For sick pets, PetSmart offers a veterinary hospital in many of its locations.
PetSmart has identified a large group who are so passionate about their pets, they are considered members of the family. The company calls these customers "pet parents" (don't we all know people like this!), and does all it can to attract and retain these customers through its PetPerks and Total Lifetime Care loyalty programs. That's good business. It is always easier and cheaper to keep an existing customer than to find a new one, and it's especially important to keep customers who are completely devoted to their animals.
Pet care is growing by leaps and bounds, and PetSmart is the largest provider in North America with $4.2 billion in sales. Petco, although now private and therefore difficult to obtain financials for, generated about $2 billion in annual sales by my calculations. According to the American Pet Products Manufacturers Association, in 2005 this was a $35.9 billion industry, more than doubling in size since 1994. The same group found in a survey that an astounding 69 million households in the U.S. own a pet, and 63% of these own more than one pet.
PetSmart faces competition from many different places, but it has a distinct advantage that I don't think can be easily replicated. For instance, while warehouse clubs such as Costco (NASDAQ:COST) may offer pet food in large quantities at a discounted price, they don't offer the product depth and knowledge, not to mention services. The same is true at local supermarkets, independent pet stores, and veterinarians.
Looking ahead, PetSmart is seeking to replicate its success by opening 100 new stores this year (which should also drive economies of scale), expanding its service business, and continuing to focus on customer service and operational efficiency, which involves issues like shorter checkout lines, store cleanliness, and making sure products are in stock.
How are the financials?
PetSmart looks to be in great financial shape. By my calculations, as of April 29, it had more than $280 million in cash and short-term investments, or more than $2 per share. Besides capital leases, it had no debt on its balance sheet.
For the first quarter, sales increased almost 10%, to more than $1.1 billion; same-store sales increased 4%, despite pet food recalls late in the quarter which hurt the top line; and service sales increased by 18%. While earnings more than doubled, to $0.78 a diluted share from $0.30 the prior year, the bottom line was boosted by a $95.4 million gain from the sale of an investment (the company sold part of its stake in MMIH, a provider of veterinary and other pet-related services).
The accounting can be distracting. But focusing on cash flow -- cash is king and also harder to manipulate -- we see that thanks to a substantial increase in cash flow from operations, PetSmart generated more than $50 million in free cash flow (cash flow from operations less capital expenditures), versus less than $17 million last year. The company used some of this prodigious cash flow to repurchase shares, spending $27 million to buy 914,000 shares. Given this, should it continue to perform well, I expect further share buybacks.
Valuation
Given the stability of PetSmart's business, its trailing P/E of 18 seems attractive. The company has recently affirmed its guidance for the second quarter, and for the year. It expects its bottom-line earnings to be $0.26-$0.28 for the quarter.
PetSmart's business is solid and it has a durable competitive advantage, based on the scope of its services, its products, and the quality of customer care and knowledge. While the company may be have discontinued its State Line Tack, a line of equestrian supplies, I'd bet my money on this stock in a horse race with its competitors.
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Fool contributor Larry Rothman is happy to receive feedback, and promises to read it when not being wrestled by his three children. He doesn't have any positions in the companies mentioned. The Fool has a disclosure policy.
