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The Pet Economy: Purring Along Nicely

On May 21, shares of PetSmart (PETM) tumbled 9% after the largest U.S. pet retailer reported quarterly results. But don't blame that drop on America's pet owners. All signs indicate that while U.S. consumers cut back on most other luxuries, spending on pets remains strong.

Despite a serious recession, the American Pet Products Assn. estimates Americans will spend $45.4 billion on pets in 2009, up 5.1% from last year and nearly double pet spending a decade ago. That optimism isn't contradicted by PetSmart's latest results. For the quarter ended in April, PetSmart's earnings were 37¢ per share, handily beating both analysts' expectations of 30¢ and results from the year before of 32¢. The company raised its predictions for 2009 earnings.

Same-store sales at PetSmart were up 3.9%. Traffic at its stores actually increased (but only 0.1%), the first rise in traffic in two years. Given the tough economy, that's an impressive feat. PetSmart "seems to be seeing more consistent traffic than one would assume could happen during a trade-down macroeconomic environment," wrote Stifel Nicolaus (SF) analyst David A. Schick.

Window into the Pet Economy

Deutsche Bank (DB) analyst Mike Baker said PetSmart beat expectations by controlling expenses and driving traffic to its stores through sales and other promotions. Plus, Baker wrote, the chain has an advantage in a downturn: The "need-based nature of pet food," which makes up more than half of PetSmart's business.

As one of the only large public companies focused solely on pet care, PetSmart's results are an important window into the U.S. pet economy. Its main national competitor, Petco, no longer reports results, ever since it was bought by private equity firms in 2006.

Other competitors include big-box retailers such as Target (TGT) and Wal-Mart (WMT), which have also exploited the rise in spending on pets. Another pet-focused stock, veterinary service provider VCA Antech (WOOF) is up 21% this year. On Apr. 22, the company managed to report a 3% rise in both net income and revenues last quarter.

The relative strength of the pet economy is reflected in PetSmart's stock price. In the last 12 months, while the broad Standard & Poor's 500-stock index dropped 36%, PetSmart shares have fallen just 8%. In 2009, through May 20, shares of PetSmart had risen 21%.

Shares, however, tumbled 8.7% to 20.35 on May 21 despite the better-than-expected results. The main culprit may have been comments from Goldman Sachs (GS). The investment bank's analyst Matthew Fassler downgraded the stock from buy to neutral.

Recent Slowdown in Sales

In doing so, Fassler praised PetSmart. "[It] has executed well, posting some of the strongest sales and earnings growth in retail," he wrote. But, he warned, "we see an absence of catalysts" for the stock going higher. PetSmart sales figures benefited in the past year from a rise in food prices, but those inflationary pressures are fading, he said.

In addition, PetSmart Chief Financial Officer Lawrence Molloy told analysts May 20 that "business did slow a bit toward late April and the slowdown has continued into the first couple of weeks of May." Goldman's Fassler called that "a trend that may or may not last," but added it "suggests the tenuous nature of [PetSmart's] sales trajectory."

That may be true, but PetSmart has some advantages, including $210 million in cash at the end of the quarter. While other retailers hoard cash, the company has been buying back shares, including $25 million of equity in the first quarter. "We are executing well despite the economic climate and continue to define the pet specialty customer experience," Chairman and Chief Executive Philip Francis told analysts May 20.

A recent slowdown in sales and traffic does raise concerns about PetSmart and other pet businesses. But there's no denying that the importance of pets has risen significantly for U.S. consumers in the past couple of decades. Investors can take comfort that as the overall economy slumped, the pet economy performed well in the past year and may continue to hold its own in the months to come.

Steverman is a reporter for BusinessWeek's Investing channel.

Steverman is a reporter for Bloomberg News in New York.

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