Wednesday, January 11, 2006

My first attempt at a research report.

Are you a value investor or a growth investor? Why not be both? PetSmart represents both a value and room for growth. Think I'm a fool? Bring your dog to Walmart, Target, PetSmart, and Petco, and see which store gets the tail wagging. What does your dog know that the market doesn't? It all starts with being as smart as pets. While every other retail is focusing on capturing more human customers, PetSmart is focusing on a largely untapped customer base of pets.

70% of Americans have pets. Pets in the last decade have become an extension of our families. PetSmart has high profit margins off of their services (not products). The market thinks PETM's competition is Wal-Mart, and in the last few earnings conference calls, analysts have asked about Target as competition. But Target and Wal-Mart sell dog food, not services. Target will not let you leave your dog in a doggie hotel, or groom your cat, nor sell you pet medications (unless of course you knock on the back door three times and ask for Carlos). PetSmart's real competition is Petco and themselves. It is a near oligopoly situation, with room for more growth, both in number of stores and in services such as in store veterinarians.

The market is overlooking how many people have pets, and how many people think of their pet as a child. If there is a recession, are people going to stop buying pet meds, or grooming their dog? No. In fact PetSmart's sales have been high through the last few years. After Katrina hit they announced that they were concerned about their upcoming quarter because they didn't know where the economy was going. That is more than fair. Every company should be so honest. The fact is when gas was getting up to $3 a gallon no one could predict what would happen. Families were spending several hundred dollars more than they were weeks earlier on gas. That hurts. PetSmart acknowledged that and it hurt their stock. But they are strong...and the market will recognize that when they announce their earnings each quarter over the next 12 months.
But who cares about words? Let's look at the numbers. Net Income has steadily increased over the years, as has cash flow from operations. In fact, PETM has experienced double-digit growth in cash flow from operations over the last few years. You have got to like a company that can make cash.

They are quite liquid as evidenced by their 1.8 current ratio, and impressive .66 quick ratio. The latter tells me that PETM could pay off two-thirds of the debt tomorrow if they wanted to. PETM doesn't need to roll over, nor beg to get a treat from lenders.

They are growing. We saw that with a few of their aforementioned ratios, but they are also adding stores and incorporating a new distribution center. PETM opened 5% more stores last quarter alone. Their higher margin services sales increased 23.9% last quarter.

PETM’s Operating Profit Margin of 7.9% means that PETM is making $7.90 on every $100 dollars of sales, which is almost an entire dollar below the top 100 average. It would appear that the top 100 retail companies are outperforming PetSmart in terms of profitability from operating margins. But PETM’s ROA fairs better against the industry’s top 100. PETM returned nearly $2 more per $100 of assets than their peers. PETM’s ROCE was in line with their peers.

Management is also buying back shares, which shows that they believe the best investment right now is themselves. The market isn't throwing PETM a bone, so they are uncovering their value by buying up themselves.

Is PETM a buy? Don't take my word for it, your dog's wagging tail says it all.


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