PETS Faces Tough Competition

PetMed Express (PETS - Analyst Report) reported first quarter sales that were $3 million ahead of our forecast, and its earnings per share were $0.02 ahead of our estimate. The EPS upside was due to the sales upside, expense controls, and a lower share count. The company reduced its total operating expense ratio by 70 basis points year-over-year. Going forward, we think the company should be able to maintain a total operating expense ratio of 24%. Favorable industry conditions and strong repeat business are offset by competitive issues, seasonality, and geographic risk. As such, we continue to rate the stock a Hold. Our target price is $15, or 17x our fiscal 2009 EPS estimate.

The investment case for buying PETS is a favorable industry environment, repeat customer business and the potential for margin expansion. Growth in this industry is expected to remain in the low-to-mid single digits. In fiscal 2008, PetMed Express had annual sales of $188 million, and we expect the company to grow its top line by 16% in fiscal 2009 and 15% fiscal 2010.

Most of the company’s revenue comes from repeat business. In the first quarter of fiscal 2009, PetMed’s reorder sales increased 16% year-over-year. The reorder business is helping drive the company’s overall sales. The real strength here is that the reorder business provides a stable, recurring stream of revenue that allows the company to focus on new areas in which to grow its business. Finally, the company’s business model could generate significant profit margin expansion in future years, as its sales climb.

Nevertheless, we are concerned with competitive pressures in the industry, seasonal sales trends, and geographic risk. The favorable industry trends have fostered a fragmented and highly competitive environment for pet medications.

Read the full analyst report on PETS