Vet Bills Strangling Your Budget? Strangle Back!

By Matthew DiLallo - May 23, 2012 | Tickers: PETS, PETM, PG, WOOF | 0 Comments

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I’ve been a lover of animals for as long as I can remember and growing up on a small farm I think we owned just about every domestic animal available.  We all have our favorite animals, mine just happens to be cats, and one of the most disappointing days in recent memory was the day my now wife told me she was allergic to those lovable fur balls. She recently discovered that there are breeds of cats that apparently are hypoallergenic and we are looking into a Siberian Forrest Cat if the rumors of their being hypoallergenic prove to be true.  Knowing that owning a pet isn’t cheap; I wanted to see if there were any investment opportunities that pet owners should consider.

The first thing I looked at was the annual costs for owning a pet; in this case I’ll use a cat because that of course interests me the most.  According to a chart I found online it costs about $500 per year for a cat with an additional $140 in starter costs, not including the cost of fluffy which in the case of the hypoallergenic cats we are looking at is pretty steep.  To further break it down into the biggest components, food costs about $120 a year, litter is about $150 and medical costs are another $150 a year.

Trying to make any sort of investment case to earn back the costs of cat food isn’t likely to benefit anyone involved.  From everything I’ve read most of the national brands are not well liked by pet owners.  Most of these brands are tucked away in a portfolio of products such as Iams and Eukanuba both of which are among the dozens of products sold by Procter & Gamble (NYSE: PG).  Of the two, Iams is the bigger brand as it one of their billion dollar brands.  However, overall product volume in their pet care segment has been declining as many newer pet friendlier brands are emerging.  Another company where pet food can be found among their portfolio of products is in Nestlé’s Purina lines but the Swiss giant is tough to invest in over in the US as their ADR’s don’t have the liquidity nor the investor interest as they trade about 500,000 shares a day compared to almost eleven million for P&G. 

With pet food offering no real investment return opportunities, another option would be to look at where you buy you pet food and supplies.  These miscellaneous supplies add up to another $80 a year and if you add in the litter and the food, you could end up spending about $350 a year at a pet store such as PETsMART (NASDAQ: PETM).  This six billion dollar a year in sales retailer is doing a nice job growing earnings as they’ve been growing by a 10% annual clip over the past five years and project to grow by double digits for the next two years as well.  This $56 stock has a decent 1% dividend yield, so if you bought 100 shares of the stock you’re dividends would cover about two months of your pet expenses.  That is of course if you could afford to buy $5,600 worth of the stock without over allocating your portfolio. 

If the title of this article caught your eye, you might know where I am going next.  In the pet heath segment PetMed Express (NASDAQ: PETS) and VCA Antech (NASDAQ: WOOF) are two of the most well-known names in the space.  PetMed Express is a nationwide pet pharmacy known for its 1-800-PetMeds direct to consumer business while VCA Antech is an animal healthcare service firm that provides both veterinary services and diagnostic testing.  PetMed Express is a bit on the small size at just a $235 million dollar enterprise; however, it does pay a very nice 5.5% dividend.  Shares have been fairly volatile; however, investors with a long term horizon should do well.   VCA Antech, however, is a consolidator in the $29 billion dollar veterinary services market which serves the 73 million pet-owning households and their 189 million pets.  Their network of 589 animal hospitals across 41 states and Canada has them providing over 6.6 million pet visits annually.  As they’ve been consolidating it has enabled them to grow revenue by about seven percent annually over the past five years.  Additionally, they project to grow their earnings by about eight percent this year and eleven percent next year which makes this $1.8 billion dollar company a fair value at its current eighteen times earnings.  VCA Antech should continue to produce slow and steady growth which will work nicely with what I am about to propose. 

With VCA Antech’s shares currently at about $21 a share, investors can set up what is called a Covered Strangle.  For this you are buying 100 shares today for about $2,100 and writing a covered call to sell those shares at $22.50 in September.  If you split the bid and ask prices for the options you should be able to sell the call for around $85 as of the writing of this article.  This gives you about a 4% yield on the cash outlay for the 100 shares.  Additionally, you have about $150 in upside in the stock between now and September which would give you up to 7% in additional profits.  Finally, to complete the strangle you’d write the September $20 puts, which again if you split the bid and ask prices, you should be able to get around a $100 for them.  This gives you a 5% yield on the cash required to be set aside for this trade.  You’d be on the hook for buying another 100 shares at $20 a share come September if the stock falls below $20.  Though, you’d still get to keep all your option income which would be $185 for a total yield of 4.5% giving you a profitable outcome as well as downside protection all the way to $18.15 a share.  There is a wide profit range on the trade and it could be repeated again every three to six months for additional payouts as long as shares stay in range.  If shares run away on you and are sold at $22.50 you’d be looking $335 in profits and a nice 8% gain on total cash required in four months. If you have any questions about the trade and how to set it up, feel free to comment.  If you have a better play on pets, I'd love to hear it.

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