PETM (Correction): Mind the Commodity Exposure

Takeaway: $PETM's commodity inputs on its food biz (53% of revs) are ripping due to the drought. That's not helping its intermediate-term mgn outlook.

Conclusion: The last time PETM had a big increase in food as a percent of mix, margins were off by 110bps. It has diversified into services since, but the run in relevant commodities is a strong consideration at peak profitability and productivity levels. Not an outright short. But keep an eye on these risk factors if you have exposure.

 

 

While PETM might not be an obvious company to watch as it relates to input price exposure, history shows that we need to keep tabs.  About 53% of PETM’s business is in the food category, which is the primary traffic driver and is significantly impacted by corn, chicken and beef prices.  The company can pass through some of this, as people obviously still have to (and want to) feed their pets.

 

But the last time there was a meaningful increase in food as a percent of mix (from 53% to 57% in ’06-08) EBIT margins came down from 8.0% to 6.9%. That might not seem like a lot, but PETM took comps higher by relying on categories other than food (services such as grooming, adoptions, training, vet services), has since recovered that margin loss by a factor of 2x, and is now sitting at peak margins.

 

With relevant commodities up 20%+ yy – which is not being helped by the drought – we need to be mindful of the sustainability of PETM’s current comp level at its existing margin trajectory.

 

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 (reasonable), and there’s a fairly even dispersion between Buy and Neutral ratings.

 

In the grand scheme of big box retail, this is actually a decent-enough business that is managed well. The category is one where sales are fairly predictable, it is not difficult to differentiate from the Wal-Marts of the world, 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 PETM hardly screens as a great short here.

 

But given current productivity and profitability levels, we need to keep in mind any margin headwinds that are building in its cost base.

 

 

Figure 1: There's little evidence that PETM can pass through enough commodity exposure to consumers to preserve margins.

PETM (Correction): Mind the Commodity Exposure - petm1

 

Figure 2: Food as a Percent of mix has fluctuated.

PETM (Correction): Mind the Commodity Exposure - petm2

 


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