Where Smart Investors Meet Smart Pets

07/15/2009 1:00 pm EST

Focus: STOCKS

Vahan Janjigian

Editor, Bottom Line's Money Masters Stock Report

Vahan Janjigian, editor of Forbes Growth Investor, likes a leading retailer of pet supplies and services.

PetSmart (Nasdaq: PETM) is a retailer of pet products and services. The company operates 1,137 stores across the United States and Canada.

According to a recent survey, 71 million US households own pets. This includes 88 million cats and 75 million dogs. PETM has grown by establishing itself as a trusted one-stop shop for pet owners. In an effort to increase market share, it opened 104 new stores in fiscal 2009 and 100 in fiscal 2008. It has also been expanding offerings within existing stores.

Merchandise accounted for 90% of net sales for the fiscal year ended February 1, 2009—more than 9,300 distinct products sold under nationally recognized and private-label brands.

Consumable products accounted for 57% of the segment’s revenues. These include pet food, treats, and litter. Hard goods, which generated 40% of segment revenues, include items like collars, leashes, medicines, grooming supplies, pet toys, apparel, beds, aquariums, cages, and filters.

Pet Services [including grooming, training, and boarding], produced the remaining 10% of PETM’s revenues. PETM will bathe pets, trim their fur and nails, and even brush their teeth. It also provides training classes that range from beginner to advanced categories. In addition, pet owners going away on business or holiday can drop off their pets at one of PETM’s 152 PetsHotels. This segment boasts higher profit margins than the Merchandise segment.

The recession has caused some pet owners to change their buying behavior, which has slowed PETM’s growth. Even so, net sales [in the first quarter of fiscal 2010] increased 9.5% year over year to $1.33 billion. Same-store sales grew 3.9% largely due to higher prices.

However, gross profit margin declined 96 basis points to 28.42%. Yet due to tighter expense controls, the operating profit margin expanded by 15 basis points to 6.77%. Net income jumped 12.3% to a better-than-expected $46.26 million, or 37 cents per share.

The recession continues to pose a threat, as do competitors Petco Animal Supplies (Nasdaq:  PETC), Wal-Mart Stores (NYSE: WMT), and Target (NYSE:TGT). Management is responding by slowing expansion. PETM opened 25 net new stores in [the quarter,] but expects to open only 16 more this year.

Management recently warned that economic conditions had become less favorable, but it also noted that operations are performing better than expected. It projected low-single-digit revenue growth for [the fiscal second quarter] earnings of 26-30 cents per share. It was more optimistic about full-year growth and increased the range of full-year earnings by two cents to $1.42-$1.52 per share.

The board of directors signaled confidence by significantly increasing the quarterly cash dividend from just three cents per share to ten cents per share. This was the first dividend increase in five years. (The stock closed above $22 Tuesday—Editor.)

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