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PetSmart, Inc. (PETM) & Petmed Express Inc (PETS): Little Followed Company Earns Outsized Profits in Pet Industry

The pet products industry is populated by great businesses. Companies like PetSmart, Inc. (NASDAQ:PETM) and Petmed Express Inc (NASDAQ:PETS) earn stable margins and high returns on capital.

It is not hard to see why these companies are doing well; U.S. consumers reliably spend more on their pets each year than they did in the last. The trend has been marked by a steady climb in spending that shows little sign of tapering off.

The fact that consumer spending on pets did not make any significant dip during the worst recession in the post-war era tells investors something important about the industry’s clientele: (1) these customers are more affluent than the general population, so they can continue regular spending on pets even during sharp recessions, and (2) customers view pet spending as non-discretionary, or at least less discretionary than things like eating out.

This makes the industry extremely attractive to those who can dominate it. PetSmart, Inc. (NASDAQ:PETM) has a defensible moat largely due to its first-mover advantage cornering the high-end pet supplies market. The company earns mid-20% returns on capital and margins that any retailer would drool over.

PetSmart is the largest company in a fragmented market; it mainly competes with small independent retailers that make good acquisition targets.

More importantly, PetSmart, Inc. (NASDAQ:PETM)’s revenue and margins held up during the recession, enabling it to continue growing while the rest of the country was in the red.

As a result of its strong competitive advantage and durable business model, the market has rewarded the company with an 18 earnings multiple. However, another — lesser-known — company is making waves in the same industry.

VCA Antech Inc (NASDAQ:WOOF) is a growing and highly-profitable owner of animal hospitals and diagnostic laboratories. While both sides of the business are profitable, the diagnostic lab segment earns the highest returns on capital.