Take Advantage of the Booming Pet Economy: PetSmart, Inc. (PETM)

The PetSmart Advantage

In 2009, when the U.S. was just entering a recessionary period, PetSmart started offering pet owners new upscale products such as organic food and specialty pet furniture. The idea of increasing high-end merchandise while facing a dismal macroeconomic environment is pretty counter-intuitive, but the results speak for themselves. Sales have increased nearly 8% annually for the past 4 years.

What’s more, the increase in high-end merchandise sales means higher margins for the company. From 2009 to 2011, the company improved its gross margin by 100 basis points from 28.5% to 29.5%. In its most recent four quarters, gross margin grew to 30.2%.

While big retailers might be able to snatch up customers looking for value, PetSmart has already started addressing a much more lucrative customer. Aside from high-end merchandise, PetSmart has an excellent foothold on in-store pet services, which comprise more than one-third of the pet-economy. This is one of the fastest growing segments of the company, as sales improved 8% in the third quarter last year.

Finally, PetSmart is just starting to grow internationally. Last year, the company entered a licensing agreement with a Korean retailer to sell its branded products. The agreement is a relatively low-risk low-cost approach to testing its brand identity in a foreign country with a similarly booming pet population.

A ‘Smart investment

PetSmart currently trades at a historically high P/E ratio. With its trailing P/E still floating above 20, it’s well above its 5-year average multiple of 18.5. However, the earnings growth continues to look strong, resulting in a forward-looking PEG ratio of 1.0.

I believe that the increase in relative price for the stock is completely justified as the company has proven it’s more than capable of outpacing the growth of its competition. However, just like any high P/E stock, even the slightest bit of bad news could cause the stock to stumble.

When PetSmart reports earnings on March 6, a miss on either the top or bottom lines could present an excellent buying opportunity. However, I expect it to continue its long run of earnings beats, so there may be no better time to buy than right now. If it goes down, you can always add to your position.

The article Take Advantage of the Booming Pet Economy originally appeared on Fool.com and is written by Adam Levy.

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