PetSmart Continues To Outperform

| About: PetSmart, Inc (PETM)
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I will admit it -- last night I was hoping that PetSmart (NASDAQ:PETM) would miss earnings estimates so that it would create a buying opportunity for me. Of course it didn't happen. PetSmart continues to do well, and it continues to grow at an impressive rate. The good news is that the company's growth story is far from over. In the last quarter, the company earned 71 cents per share, beating analyst estimates of 66 cents per share.

The company posted a net income growth of 28% and same-store revenue growth of 7%, and management increased the company's future guidance. The company posted strong revenue growth in every merchandise category (pet toys, pet leashes, pet food, and pet medicine) and all service categories (pet hotels, daycare, and grooming). This is what I call all-out growth! PetSmart sees growth from all three sides:

  1. The company's existing customers seem to spend more money in the stores than they did before, as the stores keep offering more merchandise and services than ever.
  2. It keeps opening new stores in areas that are not tapped yet.
  3. PetSmart's existing stores keep gaining visibility and attracting new customers.

This was the 10th quarter in a row where PetSmart posted an earnings growth rate above 10%. In fact, there were many quarters where the company posted a growth rate far above 10%. Americans are expected to spend nearly $53 billion on their pets this year and this industry keeps growing at a fast rate. There is still plenty of market share that PetSmart can capture in the U.S. and beyond. Currently, the company operates 1,249 stores in the U.S. and Canada, and that number is expected to double in the next decade.

The company's gross margin was also on the rise, up from 29.4% to 30.2%. This is a quarter when many companies with normally strong finances keep posting contracting margins, and it is amazing that PetSmart actually posted margin growth. The company's pet services segment is particularly profitable and the company enjoys unusually high margins for a retailer. By way of comparison, Wal-Mart's (NYSE:WMT) gross margin sits at 24%.

Because of the strong results it posted, PetSmart is raising its dividends by 18% and spending an additional $525 million on share buybacks. The company's dividend yield will barely pass 1% with the new increase, but that's OK because PetSmart is more of a growth story than value play.

Currently, PetSmart has a P/E ratio of 23. This concerns many people who rarely buy stocks with a P/E ratio above 20. I agree that there are a lot of good stocks out there with very low P/E ratios; however, P/E is just one of the many ways to determine value of a company. When it comes to growth companies posting double-digit growth almost every quarter, a higher P/E ratio is more tolerable. Analysts expect the company to earn $3.31 per share this year, $3.67 per share next year, and $4.30 per share in the following fiscal year. This gives us forward P/E ratios of 21, 19, and 16, respectively. Keep in mind that these numbers exclude share buybacks, which tend to increase earnings per share as there will be fewer shares outstanding as a result of the buybacks.

Because PetSmart has no known exposure to Europe, the investors of the company don't need to worry about the drama in that continent. In the future, when the company's growth slows down in North America, it may start pursing growth in Europe. Hopefully this won't happen for at least another five to six years and, by then, the European economy might (yes, I said "might") be in better shape than it is today.

Year to date, PetSmart is up by 37%. The company has been very good to its investors and will continue to be good to them. If another recession hits the U.S., people might end up spending less money on their pets. However, this is not very likely. In the event of a recession, all stocks will suffer the same (except for high dividend payers). Unless we have another recession anytime soon, PetSmart should perform really well.

You may ask, "Why don't you have any shares of PetSmart if you love the company so much?" Like I said in the first paragraph, I've been waiting for a good opportunity to get in PetSmart for a while but the opportunity hasn't shown itself. Currently, PetSmart isn't very expensive, but it isn't very cheap either. If a correction of any sort happens to PetSmart, I will make sure to initiate a long position in the company.

Disclosure: I am long WMT.