PetSmart is Returning Cash to Shareholders, Can they Keep it Up?
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Shares of PetSmart (NASDAQ: PETM) pounced up over 3.5% after announcing an 18% increase to their dividend and a new $525 million share repurchase authorization. In the press release announcing the return of capital plan, CEO Bob Moran said, "We believe the stability and predictability of our cash flow demonstrates the continued strength of our business." The question shareholders should be asking is if they can keep it up.
When looking for sustainable dividends that have the ability to grow over time, the industry of your target investment is a key piece of the investment thesis. The pet market in the U.S. is a $48.3 billion market that experienced 6.2% growth in 2010, according to the American Pet Products Manufacturers Association. The following chart from PetMed Express (NASDAQ: PETS) investor slide deck provides a great snapshot breaking down the industry:
PetSmart has its paws in $30 billion of the $48.3 billion pet market, and of that they were able to generate $6 billion in annual sales. The segments they are serving have seen steady growth of about 4% the past few years; PetSmart meanwhile is growing at a much faster clip of nearly 6%.
Some of their growth is more recently found in their services business -- they’ve added PetsHotels to 185 stores and Banfield, The Pet Hospital to 769 stores. Banfield, part of a joint venture, has been installed in more than 64% of their stores. To a degree this business could be seen as competition to a company like VCA Antech. Banfield though is growing much faster and certainly does have the convenience factor going for them. PetSmart is becoming an all-encompassing one-stop shop for pet owners providing them with all the products and services to meet their pets' needs. This is giving them even more avenues for growth going forward, which should supply more cash to be returned to shareholders.
This is exactly what PetSmart has been doing as they’ve exponentially increased their cash return to shareholders over the past few years. In 2008 they returned just $65 million to shareholders while in 2011 they returned about $340 million. Over the next year and a half they are authorized to return about $635 million, of which $525 million will be through share repurchases and $110 million through dividends.
With a targeted payout ratio of just 20% they have plenty of cash left over to buy back those shares that are meaningfully reducing the share count as well as build out new stores. While their dividend is currently yielding just under 1%, they have a much more balanced approach of returning cash as compared to dividend dynamo PetMed Express and their 5% yield. PetMed’s payout ratio is over 60%, which doesn’t leave as much left over.
For a lot of companies debt is a tool they use to increase their returns by either using it to fuel growth or to give it to shareholders for short-term appeasment. With no real debt on the balance sheet other than their store leases, and well over $250 million in cash at the end of the last quarter, PetSmart is growing within their means and returning cash to shareholders that actually is excess cash. The have been focused on smart capital allocation as well as increasing the return on that invested capital to the benefit of shareholders.
The industry fundamentals are favorable, the payout ratio is low and they are in a positive cash position on their balance sheet. These point to a very sustainable dividend from PetSmart.
If there is question I have it's whether the company is now leaning toward being overvalued as it popped after earnings and again with the capital return plan. At nearly 24 times earnings you are certainly paying a premium to the market, but you can understand why.
One company to keep an eye out for is Pfizer’s (NYSE: PFE) soon to be IPO’d animal health unit Zoetis. Given the compelling industry fundamentals across the board, depending on where its priced, Zoetis might be one to watch. The pet industry is one that investors should not overlook as we head into the dog days of summer.
latimerburned has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend PetSmart, Pfizer, and VCA Antech. 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.