A Guard Dog in Troubled Times

Eric is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Many investors are looking for defensive stocks right now because of the turmoil in Europe. PetSmart (NASDAQ: PETM) seems like an attractive choice because pet owners will still need to buy pet food and other pet products. I made an outperform call on PetSmart at the beginning of April, and the company's shares have risen from $57.43 to $64.51 since then. Today I decided to take another look at the company to see if its growth would continue.

PetSmart's shares soared after its May 22 earnings report, as the pet store beat both earnings and revenue estimates. PetSmart's margins also improved. Even better, Petsmart shows strength in several other important retailer metrics. Petsmart has been adding new stores, and its existing stores have become more profitable. The company had 1,232 stores at the end of 2011, 1,187 stores at the end of 2010 and 1,149 stores at the end of 2009. In its 2011 annual report, Petsmart announced that its total revenue rose by 7 percent and comparable store revenue rose by 5.4 percent in 2011. Another important retailer metric, sales per square foot, also rose from $214 in 2010 to $224 in 2011.

The Banfield hospitals and PetsHotels in some of PetSmart's stores have provided a larger share of PetSmart's income in recent years, although services only provided 11 percent of the company's total revenue in 2011. These service offerings might be more important for bringing pet owners into PetSmart stores. PetSmart's wide variety of pet products helped it compete with smaller pet shops and other types of retailers such as grocery stores, but online retailers like Amazon (NASDAQ: AMZN) can easily offer pet toys, care products, and other items.

Amazon actually did enter PetSmart's market last year with Wag.com. Although analysts did crack a few jokes about the notorious failure of Pets.com, Amazon poses a significant competitive threat to any physical retailer. Wag.com promised to deliver online orders for free within two days to shoppers who spent at least $49 at the site, while PetSmart shoppers had to pay $79 a year to obtain free two day shipping, reported Allison Enright at Internet Retailer.

PetSmart has been doing fine even with Wag.com competing in its market. PetSmart isn't the only major pet store chain, as it also competes with the private company, Petco, so an increase in sales for Wag.com might not necessarily mean lower revenue for PetSmart. The Pets.com collapse does suggest that pet products could be trickier to sell online than books and electronics, and a dog owner who realizes that he's out of dog food or discovers that his dog has fleas may not be willing to wait two days for a delivery even if the price is slightly cheaper. A PetSmart investor should still watch out for news about Wag.com, though.

PetSmart could also use a growth strategy that many grocery stores and supermarkets have used in the past by expanding its pet medication offerings. PetMed Express (NASDAQ: PETS) is a small pet medicine company that many pet owners don't know about. Because of its relative obscurity, PetMed Express has increased its ad budget, which limited its profitability. PetMed Express is much smaller than PetSmart, and PetSmart actually could afford to buy PetMed Express with its current cash reserve, as PetSmart has $291 million in cash and PetMed Express has a market cap of $230 million. If it became part of PetSmart, PetMed Express could use PetSmart's strong brand instead of spending as much money on ads.

PetSmart sells several types of products, including pet food, pest killers, and pet shelters, so it seems like it has some protection from rising prices or weaker demand in any specific pet product category. Petsmart's service offerings give the pet store even more income diversification, and they could become even more important as growth drivers in the future. The main source of potential trouble, Amazon, doesn't seem like it's hurt PetSmart's sales with its Wag.com initiative. PetSmart still looks like a buy.

enovinson has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com. Motley Fool newsletter services recommend Amazon.com and PetSmart. Try any of our Foolish newsletter services free for 30 days. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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