Conclusion: We wonder if the Street is fairly considering the relationship between commodity prices and PETM’s P&L. About 53% of PETM’s business comes from food, which is also the primary traffic driver in the stores. Relevant commodity prices have been ripping, and pricing power is minimal. It might be early to short, but with margins and productivity near peak, risk/reward looks unfavorable in the intermediate term.
History shows that the change in commodity prices (corn, chicken and beef) has a fairly low correlation to comp store sales. In other words, higher input costs don’t evenly through to the consumer. In fact, look at 2006-2008, which was the last commodity spike. Comps actually went negative. See figures 1 and 3 below.
Comps started to recover in ’08 and into ’09 when commodity prices eased. But still not to a level great enough to exceed PETM’s occupancy hurdle – which we estimate to be about 4%. Note in that same chart that despite a comp recovery, margins were still trending lower.
Commodities are up about 60% since that 2009 trough, and PETM took comps higher by relying on categories other than food (services such as grooming, adoptions, training, vet services). Note figure 2 below which shows mix going from 57% to 52% over the course of three years. As such, the company is now sitting at a peak comp on a peak margin – at a time when relevant commodities are ripping due to the drought.
The Street has generally not taken a stand on PETM in either direction headed into Wednesday’s print. The consensus is at the high end of management’s $0.61-$0.65 guidance, short interest is around 7-8% of the float, and there’s a fairly even dispersion between Buy and Neutral ratings.
In addition, in the grand scheme of big box retail, this is a decent-enough business – as sales comps are fairly predictable and inventory is easier to manage ( fish, parakeets and hamsters die at a lesser rate than apparel inventory goes out of fashion). Furthermore, compares don’t get tough on the top line for another two quarters. So it may be early to short.
But this is one that feels like risk reward does not favor the upside over the intermediate-term.
Figure 1: There's little evidence that PETM has any pricing power.
Figure 2: Food as a Percent of mix has fluctuated.
Figure 3: Commodity prices have little relationship with comps
