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Wal-Mart (WMT) And Target (TGT) No Threat To Speciality Pet Retailers Like Petsmart (PETM) And PETCO, Says Analyst At Wedbush Securities

June 29, 2011 - The Wall Street Transcript has just published Pets & Vets Report offering a timely review of the Retail sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.

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Joan Storms, CFA, is a sell-side Equity Analyst with 16 years covering specialty hardline retail companies. She has been at Wedbush Securities since 1999. Previously, Ms. Storms spent four years at Needham & Company, Inc., in New York, where she was an Analyst on the consumer/retail team following hardlines retailers. Prior to Needham, she worked as an Analyst following restaurant stocks for two years at Moran & Associates in Connecticut. Ms. Storms holds an MBA from the University of Notre Dame Graduate School of Business and a bachelor's degree in economics and business administration from Eckerd College. She is a CFA charterholder.

TWST: How important is the pet sector to the mass merchants?

Ms. Storms: The industry is highly fragmented. You have PetSmart (PETM) and PETCO, the largest specialty retailers in the U.S., which combined are probably about 20% of the market. Those companies have very good returns, so it has been an attractive area for the discounters to want to try to exploit and expand the category because it is largely consumable and it is a traffic driver. There are a lot of players in the pet market, including specialty pet stores and mega retailers, and even grocery stores, who have different levels of participation in the pet sector. Overall, though, the big retail players are PetSmart and PETCO.

TWST: How has PetSmart's stock done and how is it doing now?

Ms. Storms: It has done pretty well. Right now, it is taking a little bit of a breather. They had a pretty good roll of beating and raising estimates pretty significantly at the beginning of last year, which turned into a smaller beat-and-raise scenario in the third and the fourth quarters. But the outlook is good. There is opportunity for them to continue to expand, and part of the recovery of the general economy will help them because hard goods sales will increase. That is one of their most profitable sales areas.

TWST: What are some of the trends in the pet business in general? For example, since you just talked about the margins in hard goods, is there any sort of movement out of food into the higher-margin products?

Ms. Storms: Actually it's kind of interesting. During the recession there was some trade down in food, for example from wet food to dry food. But now with the recovery, there is a renewed interest in the higher nutrition content food and higher-quality foods, such as organic or refrigerated foods. Companies like PetSmart and PETCO are installing refrigerated units in their stores for their products.

TWST: So that's the food trend. Are there other types of trends going on in the pet sector?

Ms. Storms: During the worst parts of the recession, we saw people postponing adopting or purchasing a pet, and that whole process impacted retailers. We refer to that as pet family formation. That appears to have stabilized now; we don't hear as many tragic stories that we had been hearing about people abandoning their pets. Even though the pet shelters are full, we're not hearing horrific stories that they're overrun and that they have to put down a lot of pets. As the economy has improved, adoptions have started coming back a little bit. That is good news for the retailers because when you adopt a pet or buy a pet, you have to buy all the hard goods before you take the pet home. For example, new pet owners will want to buy a collar, food bowl and pet bed, and these items can be big-ticket drivers. Overall, we are starting to see some pick up the hard goods category with stabilization and growth going forward in pet family formation.

TWST: Going back to PetSmart for a moment, is their primary competition mega retailers or online retailers, or other specialty stores?

Ms. Storms: The real competition is from other specialty stores. As I said, it is a highly fragmented marketplace. The market share opportunity has really expanded for the larger retailers because a lot of the independents went out of business during the recession. The advantages of PetSmart or PETCO is that they are considered a one-stop shop, and you actually shop with your pets.

TWST: PetSmart also offers services such as grooming and obedience school. Is that an important part of the company?

Ms. Storms: This is another area where they were hit during the recession but have started to come back with the recovery. The training programs they offer are typically for puppies, or for new pets, or for pets that simply have problems. During the recession, people weren't adopting as many pets, and as such, demand for training fell. The boarding component suffered because people weren't traveling as much, so they didn't need to board their pets. Grooming is pretty consistent regardless of the economy. Now business is picking up in the general economy, and services are doing better.

TWST: You also cover Tractor Supply. Is their mix different than PetSmart?

Ms. Storms: They have a lot of products beyond the pet or animal space. Approximately 37% of their business is pet or animal related, and the rest is things like tractors and lawn and garden products, and hardware or truck-related and welding-related products. They carry items you would need to maintain a larger piece of land for farming and gardening and for raising animals.

TWST: Looking at the 37% that is animal related, what do those products look like?

Ms. Storms: Unlike PetSmart, Tractor Supply (TSCO) is more geared toward larger animals, versus companion animals and products for those animals. Food for both companion pets and other animals, such as horses, cows, goats and chickens, is a large part of their business. They also carry pet accessories and medicines. They actually sell chicks and bunnies during the spring season.

TWST: Are the larger retailers increasing or decreasing the pet component of their stores?

Ms. Storms: It was a few years ago when there was a lot of talk about increased competition from mass merchants like Target (TGT), which announced they were going to expand their pet business. And Wal-Mart (WMT) was getting some access, but still very limited access, to some of the higher nutrition content food. People thought this was going to be a big deal, but it really has not had much of an impact on the specialty retail sector at all. Will the management of PetSmart pay attention to what's going on in Wal-Mart Stores? Sure. If you look at Wal-Mart, most of the pet food is actually their own private label brands, although they do carry a very limited number of higher-nutrition-content SKUs that are gaining in popularity. Overall, they carry a very small assortment and there is no service. Pet owners want to know what kind of food to buy or what kind of medicines, which really requires knowledgeable customer service. And that's one thing that PetSmart has done a phenomenal job with. They train their associates about pet foods, medicines and other products.

The remainder of this 14 page Pets & Vets Report can be immediately viewed by purchasing online.

The Wall Street Transcript is a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs and research analysts. This Pets & Vets Report is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

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