PetMed Express: A Fantastic Franchise

We wanted to share our recent work on PetMed Express, which reports June quarter results Monday before market open.

We've followed PetMed's progress for at least several years and believe the company is one of the best we've come across: >70% repeat customer business (an effective annuity), no debt, mid-teens operating margins, healthy free cash flow, limited capital requirements, and an incredibly high return on net operating assets (RONA) of 76% (and ROE of 31%). In addition, PetMed is benefiting from favorable secular trends as more pet owners order medications and supplies online instead of making purchases at vets (to dismay of vet owners).

On a P/E basis, we can envision PETS trading at an 18 to 20 times multiple given the company's consistent, profitable operating model, implying a $20 to $23 fair value. We rely on absolute valuation criteria to make our purchase/sale decisions, but can't help noting that certain online retailers, from large to small, trade at much higher multiples. Amazon (AMZN) trades at 54-times trailing EPS and 41-times forward EPS, while Drugstore.com (DSCM) has no positive earnings or free cash flow, yet fetches a market cap of $193 million. PETS is an incredible bargain relative to these names.

Disclosure: Long PETS

Comments

[Jeffrey Wal...:]

Link didn't get included to my full write-up (above is only a summary) - please see:
commonstocksense.blogs...

Jul 19 09:36 PM

[Anne Marshall:]

Jeffrey, I'd like to update you on drugstore.com (DSCM). Here's a link to the Q1 2009 earnings news release when the company did report net income. investor.drugstore.com...

On Jul 19 09:36 PM Jeffrey Walkenhorst wrote:

> Link didn't get included to my full write-up (above is only a summary)
> - please see:
> commonstocksense.blogs...

Jul 20 01:58 PM

[Jeffrey Wal...:]

thanks Anne. I'm focused on normalized operating results - here's what DSCM did in the March quarter:

"Net income for the first quarter of 2009 was $1.3 million, or $0.01 per share, compared to a net loss of $2.7 million, or $0.03 per share, for the first quarter of 2008. The first quarter of 2009 net income includes $1.0 million in non-cash stock-based compensation expense and a $1.2 million benefit from the resolution reached on April 27, 2009, between the company and the State of New Jersey, regarding sales and use taxes owed by the company for the period January 1, 2000 through February 22, 2008."

So, if we take away the $1.2 million tax benefit, the company was just over break-even, and, if we view stock comp as a cash expense, then earnings were negative. Also, on a TTM basis, earnings were negative. And, the company's outlook for 2Q09:

"For the second quarter of 2009, the company is targeting net sales in the range of $93.0 million to $97.0 million, net income in the range of $250,000 to a net loss of $1.75 million, and adjusted EBITDA in the range of $3.0 million to $5.0 million."

So, forward guidance calls for break-even to a slight loss for 2Q, and, for 2009, the consensus forecast shows a loss of 7c. DSCM has scaled revenue through the years, but struggled to show consistent, positive net income. This is a low margin business model.

Jul 20 02:52 PM

[Jeffrey Wal...:]

PS - doesn't mean DSCM can't further scale and achieve positive earnings, yet the very nature of its business yields lower margins....

On Jul 20 02:52 PM Jeffrey Walkenhorst wrote:

> thanks Anne. I'm focused on normalized operating results - here's
> what DSCM did in the March quarter:
>
> "Net income for the first quarter of 2009 was $1.3 million, or $0.01
> per share, compared to a net loss of $2.7 million, or $0.03 per share,
> for the first quarter of 2008. The first quarter of 2009 net income
> includes $1.0 million in non-cash stock-based compensation expense
> and a $1.2 million benefit from the resolution reached on April 27,
> 2009, between the company and the State of New Jersey, regarding
> sales and use taxes owed by the company for the period January 1,
> 2000 through February 22, 2008."
>
> So, if we take away the $1.2 million tax benefit, the company was
> just over break-even, and, if we view stock comp as a cash expense,
> then earnings were negative. Also, on a TTM basis, earnings were
> negative. And, the company's outlook for 2Q09:
>
> "For the second quarter of 2009, the company is targeting net sales
> in the range of $93.0 million to $97.0 million, net income in the
> range of $250,000 to a net loss of $1.75 million, and adjusted EBITDA
> in the range of $3.0 million to $5.0 million."
>
> So, forward guidance calls for break-even to a slight loss for 2Q,
> and, for 2009, the consensus forecast shows a loss of 7c. DSCM has
> scaled revenue through the years, but struggled to show consistent,
> positive net income. This is a low margin business model.

Jul 20 02:59 PM

[weaponsgrade:]

Good reply Jeff...Anne Marshall is in DSCM mgt. These guys
have wasted so much $$$ over the years and their jumping for joy showing a small non-profit in 10 years of existance is sick! The profit comes from a payment from Rite Aid and not operations.
Their overhead is way too high and it has been brought to their attention over and over again for years. They have not made the
big decisions to cap their expenses. They office in downtown Bellevue, Washington, which is very high end. They have their
distribution center on the other coast...as far away as possible.
Poor, poor planning that cannot be shed.

They need to dump their high end location and relocate their corporate close to their distribution site.... Hmmm, why didn't they do that in the first place? That's a completely different story.

Mgt. has made their decisions based on self-interest. If they want to truly succeed they need to make decisions on the best interests of shareholders. IMHO


On Jul 20 02:59 PM Jeffrey Walkenhorst wrote:

> PS - doesn't mean DSCM can't further scale and achieve positive earnings,
> yet the very nature of its business yields lower margins....
>
> On Jul 20 02:52 PM Jeffrey Walkenhorst wrote:

Jul 21 01:36 AM