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Tuesday, May 20, 1997
PETsMART,
Inc. HOW DID IT FIND TROUBLE? PETsMART had been a candidate for best of show leading up to the fall of 1996, when its price peaked at $29 7/8. Since that time, this dog has been sent to the pound. The first sign of trouble was the resignation of the company's Chief Financial Officer (CFO) in January. Then the fourth quarter earnings report came out. The company narrowly missed estimates and took a hefty one-time charge. In fact, there had been a series of one-time charges over the past several earnings reports, which began to make the idea of a "one-time charge" seem a bit preposterous. Analyst downgrades and revisions of earnings estimates followed, but the real neutering of the stock came on May 2 and May 8 -- first a downgrade by the Donaldson, Lufkin & Jenrette analyst who cited weak flea and tick product sales, and then a warning that the company would miss first quarter earnings estimates. BUSINESS DESCRIPTION The Weaver household is loaded with PETsMART customers. Our two chinchillas can get all of their needs for food and comfort. We can buy fish and equipment for our two aquariums. Our three cats can get food, treats, and toys, and they can get flea dips and baths. Our two parakeets and their cages were were bought there. Our Great Pyrenees goes with us to shop and gets his 40-pound sacks of food, pigs ears, treats, and his grooming at our local store. He could even get his veterinary care there. The bottom line is that these stores have about anything you could want for any type of pet. PETsMART operates 348 stores in the U.S. and 57 stores in the United Kingdom. These stores are typically 25,000 square feet and offer over 12,000 items. Prices are usually 5% to 25% below typical pet stores. FINANCIAL FACTS Income Statement*
12-month sales: $1501 million
12-month income: $20.6 million
12-month EPS: $0.17
Profit Margin: 1.4%
Market Cap: $1486.3 million
(*Includes extraordinary charges)
Balance Sheet
Cash: $39.8 million
Current Assets: $409.2 million
Current Liabilities: $251.1 million
Long-term Debt: $77.6 million
Ratios
Price-to-earnings: 72.2
Price-to-sales: 0.99
HOW COULD YOU HAVE SEEN IT COMING? In early February on the PETsMART message board, Ayce2nd presented in very graphic terms the bearish case for PETsMART, at that time the stock was over $20 share. His beef with the stock was that the shares were overvalued based on artificially created earnings due on a series of "one-time charges." At that time, PETsMART's market capitalization was $2.7billion, while it was only expected to earn $64 million in the year ahead. In subsequent posts it was noted that profit margins were slim for pet products, which accounted for the majority of sales, inventories were rising, and same-store sales were weaker than expected. Ayce set the pace on this one, and any investor with an open mind might have seen PETsMART as a great short in the making. WHERE TO FROM HERE? Since PETsMART has now had its market cap carved in half, is it the pick of the litter? Taking a look at First Call earnings estimates you might be enticed -- the PEG is 0.36 and the YPEG valuation comes in at $30 per share. But wait a minute, the YPEG is based on the very generous assumption of 45% annual growth, a rate the company has not enjoyed these past 12 months. On top of that, there seem to be other fleas on this puppy. The accounting problems mentioned by Ayce2nd are real. The inventory buildup spells trouble as well. PETsMART is finding that is tough to move enough merchandise through 25,000 square feet of pet store to service the costs of filling the place with inventory and paying the rent. Pet food is low margin stuff, and over 90% of it is still bought at the local grocery store. Before I would bottom fish this stock, I'd like to see better inventory controls and improved earnings in the absence of charges. Perhaps some of these changes are forthcoming with a new CFO at the helm, and this dog will get up and fetch instead of rolling over and playing dead. -Mark Weaver, MD ([email protected])
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