PetSmart Capitalizes on Natural Advantages

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

Besides being one of the most successful investors in history, Peter Lynch was famous for his grassroots analysis and qualitative work on stocks.  Lynch believed potential investors should visit retail stores and try out products before committing money to a stock.  He even advocated touring factories, watching for trends and technologies in your workplace and asking people for their opinions of new products and services.  In other words, Mr. Lynch didn’t believe in armchair investing.  He believed in taking your head out of the income statement and taking your inquiry out into the street.

One company that seems to lend itself to the sort of qualitative analysis that Lynch practised is Phoenix-based PetSmart (NASDAQ: PETM).  As the name would imply, PetSmart sells cat food, dog runs and medications, as well as pet training and grooming services.  The only thing you can’t buy at PetSmart is a dog or cat, but you can adopt one at any store where the company donates space to shelters that want to offer homeless animals to the public.  Although the quantitative case for PetSmart is strong, I believe that visiting a store and understanding the story can tell you as much as reading a stock report.

A Bone to Pick with Analysts

Although PetSmart’s most recent earnings report was nothing less than spectacular, analysts have generally been and remain lukewarm on the stock due to valuation and PetSmart’s apparent lack of competitive advantages.  I don’t believe, however, that either a qualitative or quantitative analysis supports this dim view of PetSmart’s future.  Wal-Mart (NYSE: WMT) and Target (NYSE: TGT) – the two biggest competitors in the pet space – don’t offer “litter-to-grave” services like PetSmart does.  Nor do they provide the customer experience and warm fuzzies you feel in a PetSmart store. 

As for small, local start-ups nuzzling in on PetSmart’s territory, PetSmart has a leg up in its visibility with consumers and the convenience of multiple services in one location.  PetSmart trades at a premium valuation because it’s growing faster than Wal-Mart and Target.  Moreover, PetSmart’s P/E remains in-line with those of other, non-competing mid-cap retailers.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>Trailing P/E</strong></p> </td> <td> <p><strong>Market Cap</strong></p> </td> <td> <p><strong>Past 5 yrs Average</strong></p> <p><strong> Annual EPS Growth</strong></p> </td> </tr> <tr> <td> <p><strong>PetSmart</strong></p> </td> <td> <p>25</p> </td> <td> <p>$7.4 B</p> </td> <td> <p>20%</p> </td> </tr> <tr> <td> <p><strong>Tractor Supply</strong> <strong><span class="ticker" data-id="205811">(NASDAQ: <a href="http://caps.fool.com/Ticker/TSCO.aspx">TSCO</a>)</span>  </strong></p> </td> <td> <p>25</p> </td> <td> <p>$6.3 B</p> </td> <td> <p>38%</p> </td> </tr> <tr> <td> <p><strong>Dick’s Sporting Goods <span class="ticker" data-id="203313">(NYSE: <a href="http://caps.fool.com/Ticker/DKS.aspx">DKS</a>)</span></strong></p> </td> <td> <p>24</p> </td> <td> <p>$6.3 B</p> </td> <td> <p>21%</p> </td> </tr> <tr> <td> <p><strong>Wal-Mart</strong></p> </td> <td> <p>14</p> </td> <td> <p>$231.8 B</p> </td> <td> <p>10%</p> </td> </tr> <tr> <td> <p><strong>Target <br /></strong></p> </td> <td> <p>14</p> </td> <td> <p>$41.7 B</p> </td> <td> <p>6%</p> </td> </tr> </tbody> </table>

The Trends Are Your Friends

PetSmart continues to capitalize on several secular trends that show few signs of abating in the near to medium-term.  According to the American Pet Products Association, the rate of pet ownership has risen from 56% of households in 1988 to 62% in 2012.  Total spending on pets has increased almost 80% in the past decade and should surpass $53 billion this year. 

Another trend that some infer has fueled sales of high-tech pet toys, kitty condos and Halloween costumes for dogs is the increase in empty nest households in the US.  Historically, weak economies have meant lower birthrates, and with the population aging, more couples of all ages have elected to fill their nests with furry and feathery companions.  In addition, because childless couples have a higher level of education, make more money and spend more on discretionary items, child-free people will probably spend more to maintain their pets.   

Changing Attitudes Are Supporting the Pet Industry

Pet owners tend to live longer and have lower blood pressure and cholesterol levels.  They also manage stress better, report depression less frequently and make fewer doctor visits than pet-less people.  Now that science has proven what many pet parents have always known (and in light of the relentless rise in health care costs), pets are being welcomed in settings where they were once forbidden, such as hospitals and long-term care facilities.  The world has become more pet-friendly and receptive to the notion that pets are bona fide family members.  As more people clue in to the benefits of owning a companion animal, PetSmart’s business should see good support in a range of economic climes.

PetSmart Has Natural Advantages Over Competitors

If Peter Lynch visited a PetSmart store, he would probably be impressed by the spacious layout and colorful presentation of gadgets and toys.  But what I notice most in my local stores is the behavior and demeanor of customers and staff.  Most people are smiling, and customers with leashed dogs readily strike up conversations with complete strangers.  People standing in line share experiences and advice.  If you’re not happy when you go into the store, you probably will be by the time you leave because pets and the love they give make us feel that the world is better place –  or at least less challenging than it would be without our pets. 

Contrast this experience with shopping in a Wal-Mart store and you’ll see what I mean about PetSmart’s competitive edge.

As a pet owner, I have an ongoing need for food and supplies to maintain and entertain my furry friends.  I will pay a little more and drive further to find a toy or training aid that I can’t buy anywhere else.  I know I’m not alone in thinking this a small price to pay for what my pets give me every day.  PetSmart gives pet parents something its competitors can’t – the feeling of doing something good for family.

 


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