Update: PetSmart Earnings

Aug.20.14 | About: PetSmart, Inc (PETM)

Summary

PETM reported Q2 2014 results. EPS exceeded expectations and revenues in line.

PETM also announced they have hired JP Morgan to explore strategic alternatives, including a sale of the company.

The recent share price appreciation has reduced the margin of safety in PETM but shares may move higher if the company is purchased.

I did not anticipate the company would be the target of an activist in my original write-up but did believe the company was undervalued.

PetSmart (NASDAQ:PETM) reported Q2 earnings of $0.98/share, up 10.1% over last year. These results were ahead of the $0.94/share average analyst estimate. Revenues of $1.73 billion were in line with expectations. PETM also maintained their FY 2014 guidance. Comparable store sales continue to be a drag and were down 0.5% compared to the prior year. One area of strength was service offerings, a key focus of my initial coverage, which increased 4.7% and now represents 12.4% of total sales.

PETM also announced several strategic initiatives. The first initiative is the hiring of JP Morgan to pursue strategic alternatives, including a possible sale. The review of strategic alternatives is largely driven by pressure from Jana Partners. Jana Partners has identified the company as undervalued and has been pressuring the board to put PETM up for sale. PETM is also acquiring PET360 for $130 million with the potential for $30 million of additional performance based payouts. PET360 is an online pet network focused on pet specific retailing and pet information. The acquisition helps to grow PETM's online presence and adds to the overall scale of the company, helping with supply chain and supplier negotiations. Finally, PETM announced further performance improvement initiatives to drive sales growth and increase profitability.

While I am disappointed in the continued sales headwinds, PETM continues its work to grow the business and improve profitability. The growth in services is a key part of the story and shows improvement in customer engagement. Jana Partners' involvement and the potential for a sale, while not part of the original thesis, are added bonuses. Shares are up nearly 20% since my first article and are trading higher in the aftermarket on this news. However, shares now appear to be fairly valued on a standalone basis. However, they could move higher if Jana Partners gets its way and PETM is sold.

Disclosure: The author is long PETM.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.