March 4, 2008 - Is the pet supplies business recession-proof?  The answer may be a qualified "Yes" but you'd never know it by the beating taken by PetSmart (Nasdaq:PETM) in the last six months.  There are challenges to be sure for PetSmart, but with the stock price marked down 40% from its peak, investors might be wondering if the long-term attributes of this leading specialty retailer make the stock a reasonable buy here.

The amount of money spent on pets is staggering.  PetSmart and its close rival, Petco, are battling for dominance of retail pet supply which has proven to be a strong market even through weak economic times.  These retailers are riding the trend toward more health-conscious care for pets, ranging from highly specialized dog food to pet dental care products.  Such items have been around for some time but pet owners are increasingly making the commitment to take better care of their animals and sticking with it.

PetSmart is the sales leader among specialty retailers in pet supplies. The company is scheduled to report fourth quarter results on Wednesday and has already lowered guidance considerably, yet Earnings per share (EPS) are still expected to be up 9% for the quarter and 13.5% for the year.

PetSmart operates over 900 stores that offer pet supplies, grooming, training, even veterinary care in some locations.  This stock has run hot and cold with investors over the years, rattled by worries about a slowdown in consumer spending and more recently by concerns about narrowing profit margins, but PETM also has a track record of returning from the dead.

The company had to lower its guidance for fourth quarter sales and earnings, saying that same store sales would be just flat to up 1%.  With the recession cloud hanging over anything related to consumer spending, that warning was just another nail in the coffin for this stock.  Moreover, profit margins are suffering as sales of lower margin consumables hold up well but the higher margin discretionary products falter. 

Nonetheless, the overall outlook for PetSmart remains solid.  When the economy bounces back, there is plenty of potential to fuel growth through expansion via new store openings.  Analysts also note this company's market leadership in pet services, where profit margins are high.  The consensus on Fiscal Year 2007 is for EPS of $1.51, up from $1.33 a year ago.  Sales are expected to be $4.68 billion from $4.23 billion a year ago, and that figure is seen approaching $5 billion in 2008.

Analysts are forecasting an average growth rate of 16% over the next five years.  For a retailer with annual sales of $4.6 billion, that is a pretty impressive growth trajectory.  PetSmart continues to have its ups and downs from quarter to quarter, but it appears on track for delivering the overall growth story that investors have sought for so long.  So with the stock now at $21.53, a mere 14 times trailing earnings, PETM might be a reasonably priced growth stock for investors with a long-term perspective.

As with any retailer, there are merchandising, marketing, and inventory risks that can cause operating results to fluctuate at times.  We will find out this week if the bad news is fully revealed and/or priced into the stock.  If the company can get back on a course toward earnings growth in the mid to high teens, then the upside potential from current levels is intriguing.

- James Hale