I'll admit it - Amazon (NASDAQ:AMZN) has a great business model. They sell goods online and ship them to your door with great customer service. They've been challenging traditional brick-and-mortar stores by offering low prices on top of free shipping for years. When they launched Wag.com in 2011 to provide pet essentials I thought they'd take a huge bite out of PetSmart (NASDAQ:PETM) revenues. And why wouldn't they? Wag.com offers many of the same products at comparable prices. It's no surprise that Amazon threw its name into the expanding pet care industry.
The pet retail industry is both cyclical and defensive. Pet parents treat their pets more and more like members of their family. For the past decade total U.S. pet expenditures have risen, on average, over 5% annually. The American Pet Products Association is forecasting a 5% rise in expenditures for 2014. There definitely is money to be made here.
Wag.com carries many of the same national brands as PetSmart and because they're part of the Amazon franchise, customers can bundle orders across the platform to meet the minimum dollar amount for free shipping. Through a collaboration with VetSource last year, they now offer online prescription sales. Pet parents can safely order prescription medication at a discount online along with food and toys.
Within a relatively short amount of time, Wag.com has established itself as the one-stop online pet shop. Their parent Amazon has been on a tear for the last few quarters, recording sales increases greater than 20%. Unfortunately, they don't report what percentage of sales Wag.com brings in though I'm sure they have a respectable consumer base. The question left unanswered is do they have the bite to challenge PetSmart?
The PetSmart brand
PetSmart has long been the leading specialty pet retailer with 1,333 stores and 199 PetHotels. They offer training, grooming, doggie day care, veterinary services through Banfield and adoption services. They are the one-stop shop for the lifetime needs of pets and through the work of their charities improve the lives of pets and pet parents nationwide.
PetSmart is taking online competition seriously and is focusing on creating more personalized connections to continue sales growth. They recently completed the implementation of backend data and analytics tracking and can now link 90% of purchases to individual customers. With this data, they can better track customers' purchasing habits and offer personalized target awards when certain spending thresholds are met with coupons at the register and through email. Coupled with a recently redesigned website that's more user friendly their strategy really begins to materialize as shown below.
(Image from PetSmart Investor Presentation)
What truly keeps customers returning is their line of exclusive products and services. Customers enjoy products from Disney, Toys R Us and National Geographic. They are also the exclusive retailer of the Whistle Activity Monitor, a device that can monitor the activity and rest levels of dogs.
Their exclusive foods include products in natural, raw and science foods. These are not just re-branded or repackaged food products sold online by competitors like Wag.com or Target (NYSE:TGT). These are the result of close work with vendors to provide PetSmart exclusive products that customers crave and the numbers back it up. Q4 exclusive products set an all time record sales penetration, helping end the year with 26.5% of merchandise sales. Looking forward, management intends to deliver double-digit proprietary and exclusive product sales growth over the next 3-5 years spread across consumables, hard goods and specialty.
PetSmart shares have been under pressure for much of 2014. Since reaching a high of $77.32 last October the stock has lost as much as 20%. The stock closed at $66.03 Monday, down 9% YTD.
2014 guidance includes 2-4% comparable sales growth and total sales growth of 4-6%. They are aiming to deliver $4.42 to $4.54 EPS for 2014, though guiding $0.98 to $1.03 per share due to the cost associated with opening the new Northeast distribution center, investment for new mobile strategies and traffic challenges due to weather at the beginning of Q1.
Shares currently seem attractive with a P/E of 16.22, below the industry mean of 19.2. P/S is 0.94 and PEG is 1.24, below the industry mean of 1.43.
Wag.com is a growing competitor that can't be taken lightly. They benefit from being under the Amazon umbrella and are continually expanding their offerings of products. Their impressive growth helped spur PetSmart management in making the right technological investments to silence e-commerce competition. The PetSmart brand remains strong with loyal customers and won't give up much ground to online competitors. Given the recent bearish trend in the shares, I believe the market is mispricing their value. With an improving economy, the weather related challenges behind them and a progressive management team shares should appreciate after the Q1 2014 earnings release on May 21 and through the 2nd half of the year. I suggest layering in with small positions quarterly.
Disclosure: I am long PETM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.