Time To Pounce On PETS

Successful investing, especially for the long-term, is all about spotting societal trends. So it was with great interest that I looked at the recent bestselling business book, Microtrends, which seeks to highlight some of the biggest current cultural shifts. Not only is the book an interesting read, but it validates two major trends that we have highlighted at SmartGuyStocks: the growing demand for video games among adults (see SGS picks Nintendo (NTDOY.PK) and Activision (ATVI)), and the increasing popularity and importance of pets in our lives. It is this latter trend that I would like to revisit.

When I made PetMedExpress (PETS) a SmartGuyStocks selection in June, I cited the fact that people are increasingly likely to think of their pet as a member of the family. They are thus more apt to not only put money into Fido’s health care expenses, but to think of those expenses as a necessity. I reasoned that PetMedExpress, the leading retailer of pet medications, stood to benefit.

Recent press has re-affirmed that this trend is still strong: the American Pet Products Manufacturers Association [APPMA] reported that pet ownership has again reached a new high in 2007, and spending on pets overall and medications in particular are expected to rise in the high-single digits. In an article for the website Small Business Trends, the CEO of Embrace Pet Insurance predicted, “online veterinary pharmaceuticals will become more main stream. Pet lovers want, and are demanding, the same treatment options for their pets as they can get for themselves.”

Since my selection of PETS, the company certainly hasn’t disappointed. They’ve reported two stellar quarters of top and bottom-line growth, handily beating analyst expectations each time. As I recently noted, the company is successfully retaining its customers and actually reducing advertising as a % of sales, ensuring a sustainably profitable business. Most importantly in this time of credit turmoil, PETS is cash flow positive and has zero debt. In addition, they are actively buying back shares. Yet the stock has inexplicably dropped over 20% from its highs, much of that in recent weeks.

With the recent credit panic in the market, it appears that investors must be thinking of PETS as a consumer discretionary stock, lumping it in with Petsmart (PETM) and other struggling retailers. Let me see if I can follow the logic: oil prices high, dollar low, consumer confidence suffers… Fido has to die of heartworm? I can see how penny-pinching consumers might not want to buy that expensive Coach (COH) purse or even that newfangled birdhouse from Petsmart, but I highly doubt that they will deprive their beloved family pet of necessary medication.

In fact, if anything, PETS stands to benefit from any consumer thriftiness. With lower prices than vets, consumers are more likely to jump online and order from PETS if money is tight. This is not unlike Jim Cramer’s recent rationale for jumping on the bandwagon and recommending SGS pick McDonald’s (MCD). If a recession hits, consumers will still have to purchase necessities like food or medication, but will be more likely to seek out the low-cost providers like MCD or PETS.

With impressive growth and financials and the tailwind of a strong macro trend, I recommend taking advantage of this recent market downturn to double-down on our long-term bet on PETS.

Disclosure: SmartGuyAB is long PETS.