PetSmart Looking Pricey

PetSmart (Nasdaq:PETM) and privately held Petco rule the space for big-box retailing of pet products and services. PetSmart reported impressive first-quarter results last week and continues to grow steadily, but the current share price doesn't properly account for how fast this company is growing or how the intense competitive landscape is. TUTORIAL: Investing 101

PetSmart's First-Quarter Recap
Sales improved 6.8% to $1.5 billion as same-store sales grew a robust 5% thanks to the opening of five new stores and positive currency fluctuations from Canadian sales. The company ended the quarter with 1,192 total stores, while profitable service revenue from providing pet training, grooming and kennel facilities jumped 9% to make up just over 10% of total sales.

The company was able to keep costs in check as total sales expenses rose only 5.9% and lagged the top line increase. Merchandise costs made up the bulk of expenses and rose only 5.7% while service costs increased 6.9%. The end result was a 9.2% jump in gross profits to $441.4 million. Operating expense growth of 6.2% was also held below sales growth and helped send operating income up 17.8% to $121.7 million.

Lower interest expense and modest income tax expense growth pushed net income ahead by 27.5% to $70.9 million. Share buybacks helped per-share results as earnings jumped 32.6% to 61 cents per diluted share. This beat analyst projections by a fairly wide margin. (For more, see 6 Bad Stock Buyback Scenarios.)

PetSmart's Outlook
For the full year, management projects comparable store sales growth in the low to mid-single digits and total sales growth in the mid-single digits. It raised its earnings guidance to between $2.32 and $2.42 per share.

The Bottom Line
Over the past five years, PetSmart has managed to grow sales nearly 9% annually and profits at close to a 10% annual rate. This growth is enviable and there is further potential for the company to expand its store base and continue to grow its higher-margin service revenues. However, competition is intense, with diversified big-box rivals including Wal-Mart (NYSE:WMT), Costco (Nasdaq:COST), grocery store chains such as Kroger (NYSE:KR) and Safeway (NYSE:SWY), and smaller rivals including Tractor Supply Co. (Nasdaq:TSCO) all selling basic pet necessities at more competitive prices. (For related reading, see Economic Moats: A Successful Company's Best Defense.)

At a forward P/E close to 16, if the company hits the high end of its full-year guidance, the risk/reward tradeoff on owning the shares is unappealing given the intense competitive landscape and a valuation that already discounts many more years of double-digit growth. Retail behemoth Wal-Mart looks more interesting in comparison at a forward P/E closer to 12 and an ability to also grow profits in the low double digits over the long haul. (For more, see How To Use The P/E Ratio And PEG To Tell A Stock's Future.)

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