PetMed Express: The Type of Business We Like to Own

PetMed Express (PETS, $19.66) reports F2Q10 (September) results this morning before market open. We suspect the results will be just fine and the company has a history of beating Wall Street expectations (which is perilous in the event of a disappointment):

However, we know some are questioning further, near-term upside following the recent run (including push through $20 on Friday): insiders (94 thousand shares sold in past six months, see link), short sellers (down from earlier this year, but still 5.0 million shares or 22% of float, see link), and Jon 'DRJ' Najarian's optionMonster.com ("Options Turn Bearish on PetMed Express", see link).

OptionMonster notes that "The $20 mark served as resistance for PetMed Express in [March] 2006, and at least one trader expects that level to keep the stock in check again now." We can't help but submit that PetMed Express is in a different place than in early 2006: the company will earn more than one dollar (consensus F10E = $1.14) this year versus only $0.50 in F06 (end March). We include a five year stock chart below:


Indeed, based on our model, PetMed Express is no longer a bargain. Aside from discounted cash flow (DCF) analysis, the company generally appears fairly valued depending upon approach:

• DCF assuming 10% cost of capital and 2% terminal growth = $29 fair value
• FCF multiple of 20x F2011E FCF (discounted 1.5 years to 9/30/09) = $20 (18x = $18)
• Private Market Value (PMV) with capitalization rate of 10% applied to F2011E EBITDA = $25 ($21 discounted to 9/30/09)
• Earnings Power Value (EPV) with capitalization rate of 10% applied to F2011E adjusted EBIT = $17 ($15 discounted back)

That said, the company's established niche market position and financial performance in the face of a "couple dozen online competitors" (per management - see this presentation, slide 11) should enable sustainable forward growth and significant excess cash generation, thereby lending support to the DCF valuation.

Our model shows net cash/investments per share increasing to $5.50 per share in F2013 (3.5 years) from $1.90 at year-end F2009 (March) assuming the current dividend of $0.40 growing 10% per year but no incremental share repurchases (*unlikely, but we're allowing cash to simply build on balance sheet). These are the types of businesses we like to own.

Disclosure: long PETS.

Comments

[Alan Brochs...:]

JW, what do you think about the competitive environment? This one caught my attention a couple of months ago, and I liked what I saw initially. Then, coincidentally, Amazon sent me an email regarding their pet offerings. Certainly not as extensive a selection, but the prices were so much lower and on things that I would buy.

Oct 19 09:25 AM

[granger:]

I added aggressively below 17.50 today. I am a long term hold though, have been for 2 years. I love the model and debt free balance sheet. (not complaining about that divvy either)

The key to PETS is the prescriptions, just my opinion. Not saying, that they could not get hurt on margins, but I believe they can defend given their operating structure, with high re-orders. Just my opinion.

Oct 19 04:41 PM

[Jeffrey Wal...:]

Hi AB, thank you for your question. We can't take competition lightly, especially that from Amazon. You're right that Amazon offers quite a few products for pets (non RX) -
www.amazon.com/pet-sup...
And, some popular medications are less expensive - for example, Frontline Plus for 45-88 lb dogs six doses:
$66 at Amazon www.amazon.com/Merial-...

and $89 at PetMeds www.1800petmeds.com/Fr...


On Oct 19 09:25 AM Alan Brochstein wrote:

> JW, what do you think about the competitive environment? This one
> caught my attention a couple of months ago, and I liked what I saw
> initially. Then, coincidentally, Amazon sent me an email regarding
> their pet offerings. Certainly not as extensive a selection, but
> the prices were so much lower and on things that I would buy.

Oct 20 02:28 PM

[Jeffrey Wal...:]

sorry, partial response was published - here are a few more points: So, we need to watching pricing, although I suspect Amazon may be discounting more intensely now that the peak selling season is over.

Where PetMed Express differentiates is by offering RX medications (30-31% of revenue) and a wide selection enabled by the company's niche focus (and, per management, a focus on customer care, which - of course - most companies point to). Also, the company's volume should enable very competitive pricing since it controls more than one half (6% share) of the direct mail pet medications market (11% share of total market, offline and online).

Aside from the strong balance sheet, I find solace in PetMed's large repeat business (70%), which still grew 11% Y/Y in the September quarter, and the company's large accumulated customer base (more than 5.1 million, with 2.5 million active in past 24 months). Loyalty remains high.

Just because Amazon moves into an area, doesn't mean they will dominate the category or not look to potentially make an acquisition to strengthen offerings (e.g. Zappos).

JW

On Oct 20 02:28 PM Jeffrey Walkenhorst wrote:

> Hi AB, thank you for your question. We can't take competition lightly,
> especially that from Amazon. You're right that Amazon offers quite
> a few products for pets (non RX) -
> www.amazon.com/pet-sup...;node=12923371
>
> And, some popular medications are less expensive - for example, Frontline
> Plus for 45-88 lb dogs six doses:
> $66 at Amazon www.amazon.com/Merial-...;s=pet-supplies&am...
>
>
> and $89 at PetMeds www.1800petmeds.com/Fr...
>

Oct 20 02:42 PM