Wednesday, April 12, 2006

Fido's Day: Assessing the Pet Need Specialists

Americans are pampering their pets more than ever before -- fact.

Currently, over 60% of American households possess a pet -- that's over 350M cats, dogs, and hamsters. Analysts have the pet supply industry pegged at $36 billion dollars and we think that with the explosion of young professionals and retiring baby boomers (who've finally got the kids out of the house) providing most of the gas, pet ownership will continue to grow at an impressive pace.

Here's a quick look at the three largest players in the pet needs category:

PetSmart (PETM) Petsmart sells pet food, supplies, and related services. Petsmart just posted a great 4Q with same store sales up nearly 5%. Because it's getting bigger, Petsmart is finding more leeway with its suppliers -- a sign of improving profitability. Right now, PETM is reformatting stores and introducing new services. As a veritable superstore, PETM stocks roughly 13,000 items, eons more than what any private mom and pop could ever inventorize. PETM's sales-per-square foot are higher than Petco's (as are operating margins) and new store additions in less-represented territories should push shares higher over the next 12 months.

PetCo (PETC) Meet Petco, Petsmart's arch nemesis. We like how Petco possesses better, more convenient store locations and leverages its P.A.L.S. loyalty program. However, there are some things we have to bark at: Insiders do more selling than they do buying and Petco's smaller store format could leave it at a disadvantage to Petsmart. Additionally, with $150m in debt, PetCo's financial health could use some spring cleaning. Although it's not a dog (insiders still own a large chunk of the stock), Petco's our least favorite name in the group.

PetMed Express (PETS) Woofie got a cough? Enter PetMed Express, the leader in online pet medicines and related products. We like how PETS pushes drugs out the door in 2 days or less, as well as the fact that the segment/niche this name controls is expected to grow 15% in F2006. The greatest growth opportunity is in this stock, we think, since revenues are expanding at a brisk pace. The firm is spending somewhat heavily on ads to boost its customer acquisition/retention rate, so we'll have to see how quickly PETS can monetize these efforts. The stock's had a great run thus far, proof that investors are minimally concerned with the brick-and-mortar threat to an internet-contingent company like PETS. Insiders own 14% of the shares outstanding and the company holds no debt.

Analyst Summary

Favorable demographic trends should fuel further pet stock price increases. Given the moderate risk (mostly gas price and interest rate-driven) surrounding these names, we'd gladly pick up shares of all three if the market ever provided a rare buying opportunity.

Our favorite name in the group -- also the riskiest bet -- is PETS. Take a look at this provocative chart comparison so that you can see how much damage this puppy's already done. If you'd like a print-ready version of this report, take a look at this. This PDF is similar to what paid subscribers receive weekly, weeks before it appears on this site, along with extra coverage and/or industry news, trends, and surveys.

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