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PetSmart: Can Strong Earnings Get Shares Back on Track?

By Joseph Solitro – Mar 3, 2014 at 4:24PM

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PetSmart is about to release its fourth-quarter earnings, so let's see if we should be buying right now or if we should avoid it until the release.

PetSmart (PETM), the largest retailer of pet products and services, is set to report its fourth-quarter results before the market opens on Wednesday, March 5. Its stock has widely underperformed the overall market in 2014 with a fall of more than 8%, but the tide could change after one strong set of earnings. Let's take a look at the current expectations for PetSmart and decide if we should buy shares before the release or if we should wait to see what the company has to say.

Source: PetSmart.

The last time out
On Nov. 22, PetSmart reported its third-quarter results for fiscal 2013. Here's an overview of the report with a year-over-year comparison:

Earnings Per Share $0.88 $0.86
Revenue $1.70 billion $1.70 billion

Source: PetSmart Services.

PetSmart's earnings per share increased by 17.3% and revenue increased by 4% year over year, driven by comparable-store sales growth of 2.7%. Sales from pet services led the way during the quarter, showing growth of 5.2% to $184.2 million. Gross profit rose by 4.7% to $504.97 million and the gross margin expanded 20 basis points to 29.8%, helped by lower merchandise costs. In addition, PetSmart generated $107 million in free cash flow, which allowed the company to pay $17 million in dividends and repurchase $30 million of its common stock. In summary, this was a very strong quarter for PetSmart and it showed the strength and stability of the pet products industry.

Expectations and what to watch for
Here's a breakdown of what analysts expect to see from PetSmart's fourth-quarter results:

Earnings Per Share $1.22 $1.24
Revenue $1.83 billion $1.88 billion

These expectations call for PetSmart's earnings per share to decline by 1.6% and revenue to decrease by 2.7% year over year. I think PetSmart has the size and strength to report flat earnings, but I expect the company to meet expectations at the very least. I believe this for two reasons: the overall growth of the industry and the promotions offered to drive customer traffic in the holiday season.

First off, the American Pet Products Association estimated that Americans spent more than $55.5 billion on their pets in 2013, a 3.8% increase from 2012; with PetSmart being the largest player in the market, it is almost guaranteed to see a revenue boost. Secondly, PetSmart offered numerous holiday promotions to help bring customers and their pets in; these included the very popular 12 Days of Deals event and the Santa Claws Photo Event. I believe these promotions helped drive customer traffic and will result in a higher average ticket price and better-than-expected comparable-store sales during the quarter.

Source: PetSmart.

Other than the key metrics, the most important information to watch for will be PetSmart's outlook on fiscal 2014; currently, analysts' estimates call for earnings per share in the range of $4.22-$4.60 on revenue of $7.2 billion-$7.4 billion. I would also like to see the company maintain its gross margin of 31.6% from the year-ago period, but anything above 31% would be an added plus. If PetSmart can deliver on earnings and report an outlook within the projected range, I believe its stock could slowly push back to its 52-week high, which it sits more than 14% below today.

How has the competition performed? 
PetMed Express (PETS -1.12%), the owner of 1-800-PetMeds, is one of PetSmart's largest competitors in the pet product and medication industry, although unlike PetSmart, 1-800-PetMeds does not have brick-and-mortar locations, as it conducts all of its business online or over the phone. The company reported third-quarter earnings on Jan. 21, giving insight into the condition of the industry's online presence; here's an overview of the results and a year-over-year comparison:

Earnings Per Share $0.23 $0.23
Revenue $50.10 million $52.06 million

PetMed Express' earnings per share were flat and revenue increased by just 1% from the same period a year ago. Online sales increased by 2.1% to $39.5 million and this has continued to be the dominant source of business for the company, representing 78.8% of its total sales. As you can see, the company's struggle to gain more customers has continued, and the stock has reacted by falling more than 7% in the weeks since then. The only bright spot about PetMed's stock right now is its 5% dividend, but I do not think this is reason enough to invest. With this said, PetMed Express' challenges are not a sign of things to come for PetSmart, because e-commerce only makes up a small percentage of PetSmart's total sales.

The Foolish bottom line
PetSmart is an American titan that is expected to report negative fourth-quarter earnings and revenue. I do not agree with the estimates and believe the company will report flat earnings year over year, but the most important factor will be PetSmart's outlook on 2014. If PetSmart can report earnings within a few percent of analysts' estimates and pairs this with a strong outlook, I think its shares could rally toward their 52-week high. With this said, Foolish investors should be cautious with PetSmart's stock and consider waiting until after the release to initiate positions. This way, we will have the most up-to-date financial information in hand so we can make an educated decision about whether to invest in the company.

Joseph Solitro has no position in any stocks mentioned. The Motley Fool recommends PetSmart. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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