Analyst upgrades and downgrades are just part of the market. It seems like every year there are more research firms capable of issuing their opinion on a company or a sector -- and trying to make sense of the upgrade or downgrade history of a company can be downright impossible. My Foolish colleague Rich Smith knows this well, as he covers a copious amount of analyst actions on a near-daily basis.
My usual rule of thumb is to completely ignore upgrades and downgrades, because they're almost always short-term share-price drivers. In short, analyst actions should rarely have much bearing on your buying or selling strategies in a company.
But a call made yesterday by Nomura Financial on PetSmart (NASDAQ:PETM) is going to coerce me to step outside my box and dub it the worst call of the week – maybe even the month!
Nomura's covering analyst, Aram Rubinson, lowered PetSmart to "reduce" from "neutral" and drastically lowered his firms' price target on the company, to $55 from $72. Central to Rubinson's argument is his belief that Amazon.com (NASDAQ:AMZN) will become a greater competitor to PetSmart as shipping costs fall. Rubinson notes that as Amazon builds more distribution centers in higher-populated areas, its shipping costs for heavier food items will give it a distinct advantage over PetSmart.
As a pet owner, I see three major flaws with this analysis.
First of all, this analysis assumes that the market for pet products is stagnant when, in reality, that market is expanding at a rapid pace, according to research by the American Pet Products Association.
If the chart above appears familiar, that's because it is. It's one of the primary reasons I mentioned for being excited about Pfizer's upcoming animal health division spinoff, Zoetis. The pie for pet dollars is expanding, which means that market share gains can be a bit fluid and yet everyone can still come out a winner. Even if Amazon were to garner a few sales of heavier food items, the general trend of 3% to 4% growth in annual pet product spending should fuel PetSmart's bottom line.
Second, convenience is an important factor when it comes to making purchases online, but pet owners have been generally resistant to this trend when it comes to their furry friends. Now, don't take my words out of context here, because we have seen a dramatic jump in direct-to-consumer sales in pet products and medications. Online pet pharmacy PetMed Express (NASDAQ:PETS) has grown sales by an average of 15.8% over the past decade as it's relied on the convenience factor and a slight undercut to brick-and-mortar pricing to push sales. However, sales for PetMed Express have plateaued in recent years as pet owners prefer the personalization of care and recommendation that comes with an in-store experience.
Finally, Rubinson fails to mention what I feel could be the biggest threat to PetSmart: Wal-Mart (NYSE:WMT). The world's largest retail chain has more than enough clout to be able to undercut PetSmart or privately held Petco on pricing. What's stopped Wal-Mart from becoming a major force in this space is the simple fact that consumers don't think of Wal-Mart when it comes to pet supplies. PetSmart and Petco are often seen as the "have-it-all" stores for pets, and until Wal-Mart promotes this fact, it can expect only marginal market-share gains at best.
The way I see it, PetSmart is just as strong today as it was yesterday. PetSmart reported a 46% increase in net income on a 9% increase in revenue in mid-November, and boosted its full-year forecast, crushing Wall Street's estimates. Same-store sales were also up 6.5% as customers "bought more goods and services in its stores" [emphasis added].
This isn't rocket science; pet owners still prefer the personalization of brick-and-mortar locations, and Amazon is far from a threat with the pet products "pie" increasing annually. Nice try, Nomura, but you're getting a dunce cap for this one.
Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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