PETMED EXPRESS INC PETS S
July 11, 2013 - 6:31pm EST by
MJS27
2013 2014
Price: 14.45 EPS $0.00 $0.00
Shares Out. (in M): 20 P/E 0.0x 0.0x
Market Cap (in $M): 290 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 272 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

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  • High Short Interest
  • Pet Care
  • Pharmaceuticals
  • Low market penetration
  • online marketing

Description

While I am sure that most VIC members wisely ignore most of the drivel on CNBC, as someone who works on a sales trading floor I cannot avoid it.  Thus I have been unable to avoid noticing the massive uptick in commercials for 1-800-Pet-Meds (PETS) over the last several weeks.   This is the signal I have been waiting for to short PETS.  For reference, PETS was previously written up short in 2010 by TomBrady.

First, I realize this is not for everyone - the company pays a high dividend and is already highly shorted.  However, due to the short time frame here, I thought it was worth posting.  I believe that when the company reports earnings in less than 2 weeks on 7/23 the shorts that have been squeezed to the current price will be vindicated.

If you’re not familiar with the name PETS is an online pet pharmacy.  Historically pet pharmaceuticals were dominated by veterinarians, and the bull case has always been that PETS would eat the vets’ lunch over time by undercutting them on price.  I was actually long this stock in late 2011 based on that theory.

At the time, the PETS investor presentation showed that the pet medicine market was split as follows:

Vets 67%
B&M Retail 22%
PETS 6%
Other Mail Order 5%

The PETS investor presentation now shows that the pet medicine market is split as follows:

Vets 63%
B&M Retailer 25%
PETS 6%
Other Mail Order 6%

 You will notice that the Vets are losing ground, but PETS is not gaining ground.  The big jump here is obviously brick & mortar.  The bulls will say this is tied to the currently impaired discretionary spending environment.  At PETS the average order size is $73 (down from $80 in 2008) and consumers who do not want to buy in bulk will just grab and go at their local Walmart.   This may make sense and consumers may return to online ordering at some point, so I will focus on the increase in “Other Mail Order."

From my notes back in 2011 I see that a google search for “advantix flea” resulted in 1-800-Pet-Meds and one other internet retailer.  The same search today returns www.petparents.com, bugetpetcare.com, vetrxdirect.com, wag.com, DrsFosterandSmith.com, allvetmed.com, vetinternetco.com and 1800Petmeds.com

It is obvious that there are low/no barriers to entry in this business, but bulls will argue that 1800PetMeds has brand equity and is the most recognizable name in the space.   This claim is an important part of the short thesis and is directly tied to the imminent timing.  

 The financials shows that margins have been steadily declining for the last 2-3 years, however FY13 showed an improvement.

  FY13 FY12 FY11 FY10 FY09 FY08
Sales 227,830 238,250 231,642 238,266 219,412 188,336
Gross Margin 33.8 33.7 36.2 38.6 38.9 39.4
Profit Margin 7.53 7 9 10.9 10.5 10.6
EPS 0.86 0.8 0.92 1.14 0.98 0.82

Drilling down to a quarterly level shows that the primary reason that the FY13 margins were able to expand is that ad spending was aggressively cut in the back half of the year.   In fact in Q313 (reported 1/22/13) ad spending was cut 16% YoY, which led a 19% YoY EPS increase.  In Q414 (reported 5/6/13) ad spending was cut 19% YoY which led to a 15% YoY EPS increase.

  Q3'13 Q3'12 Q3'11 Q3'10 Q3'09
Sales 49,609 50,523 45,118 48,353 43,406
Gross Margin 34.7 34 37.5 38.9 39.9
Profit Margin 9.2 7.7 10 11.6 11.3
EPS 0.23 0.19 0.2 0.25 0.21
           
Ad Spending 4,613 5,456 4,421 5,173 4,644
           
  Q4'13 Q4'12 Q4'11 Q4'10 Q4'09
Sales 51,120 55,920 50,910 50,300 48,070
Gross Margin 35.7 33.9 34.3 39.9 40.3
Profit Margin 9 7.1 8.2 12.1 11.75
EPS 0.23 0.2 0.19 0.27 0.25
           
Ad Spending 5,600 6,900 5,500 4,900 5,100

These cuts to ad spending made sense at the time – ad spending has historically been their biggest expense after COGS and rates in Q3 were high due to the election.  I suppose they didn’t ramp up in Q4 due to the seasonal slowness.

Regardless, this is a company with no moat selling commodity products.  If the bulls are correct and this company has brand equity, they NEED to defend it through aggressive ad spending.  When the company reports in 2 weeks either 1) we will see that they have increased ad spending and thus hurt their margins or 2) they have not increased ad spending and therefore their sales have suffered due to the growing competition.  As the CNBC anecdote illustrates I believe that option 1 is the more likely case.

This is a company that has seen a steady decline in its business and is facing a more difficult future.  They have temporarily been trying to hide these facts by cutting an essential piece of their business model, yet currently trade at the highest multiples they have seen in 3 years (16.8x trailing PE).  It is also worth noting that the last time the stock saw similar multiples they had more than $50M in cash on their balance sheet, and now they have less than $20M, making a buyback announcement etc less likely.   

Risks:

Share holder friendly management

Traditionally high ROE business

Already high short interest

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

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    Description

    While I am sure that most VIC members wisely ignore most of the drivel on CNBC, as someone who works on a sales trading floor I cannot avoid it.  Thus I have been unable to avoid noticing the massive uptick in commercials for 1-800-Pet-Meds (PETS) over the last several weeks.   This is the signal I have been waiting for to short PETS.  For reference, PETS was previously written up short in 2010 by TomBrady.

    First, I realize this is not for everyone - the company pays a high dividend and is already highly shorted.  However, due to the short time frame here, I thought it was worth posting.  I believe that when the company reports earnings in less than 2 weeks on 7/23 the shorts that have been squeezed to the current price will be vindicated.

    If you’re not familiar with the name PETS is an online pet pharmacy.  Historically pet pharmaceuticals were dominated by veterinarians, and the bull case has always been that PETS would eat the vets’ lunch over time by undercutting them on price.  I was actually long this stock in late 2011 based on that theory.

    At the time, the PETS investor presentation showed that the pet medicine market was split as follows:

    Vets 67%
    B&M Retail 22%
    PETS 6%
    Other Mail Order 5%

    The PETS investor presentation now shows that the pet medicine market is split as follows:

    Vets 63%
    B&M Retailer 25%
    PETS 6%
    Other Mail Order 6%

     You will notice that the Vets are losing ground, but PETS is not gaining ground.  The big jump here is obviously brick & mortar.  The bulls will say this is tied to the currently impaired discretionary spending environment.  At PETS the average order size is $73 (down from $80 in 2008) and consumers who do not want to buy in bulk will just grab and go at their local Walmart.   This may make sense and consumers may return to online ordering at some point, so I will focus on the increase in “Other Mail Order."

    From my notes back in 2011 I see that a google search for “advantix flea” resulted in 1-800-Pet-Meds and one other internet retailer.  The same search today returns www.petparents.com, bugetpetcare.com, vetrxdirect.com, wag.com, DrsFosterandSmith.com, allvetmed.com, vetinternetco.com and 1800Petmeds.com

    It is obvious that there are low/no barriers to entry in this business, but bulls will argue that 1800PetMeds has brand equity and is the most recognizable name in the space.   This claim is an important part of the short thesis and is directly tied to the imminent timing.  

     The financials shows that margins have been steadily declining for the last 2-3 years, however FY13 showed an improvement.

      FY13 FY12 FY11 FY10 FY09 FY08
    Sales 227,830 238,250 231,642 238,266 219,412 188,336
    Gross Margin 33.8 33.7 36.2 38.6 38.9 39.4
    Profit Margin 7.53 7 9 10.9 10.5 10.6
    EPS 0.86 0.8 0.92 1.14 0.98 0.82

    Drilling down to a quarterly level shows that the primary reason that the FY13 margins were able to expand is that ad spending was aggressively cut in the back half of the year.   In fact in Q313 (reported 1/22/13) ad spending was cut 16% YoY, which led a 19% YoY EPS increase.  In Q414 (reported 5/6/13) ad spending was cut 19% YoY which led to a 15% YoY EPS increase.

      Q3'13 Q3'12 Q3'11 Q3'10 Q3'09
    Sales 49,609 50,523 45,118 48,353 43,406
    Gross Margin 34.7 34 37.5 38.9 39.9
    Profit Margin 9.2 7.7 10 11.6 11.3
    EPS 0.23 0.19 0.2 0.25 0.21
               
    Ad Spending 4,613 5,456 4,421 5,173 4,644
               
      Q4'13 Q4'12 Q4'11 Q4'10 Q4'09
    Sales 51,120 55,920 50,910 50,300 48,070
    Gross Margin 35.7 33.9 34.3 39.9 40.3
    Profit Margin 9 7.1 8.2 12.1 11.75
    EPS 0.23 0.2 0.19 0.27 0.25
               
    Ad Spending 5,600 6,900 5,500 4,900 5,100

    These cuts to ad spending made sense at the time – ad spending has historically been their biggest expense after COGS and rates in Q3 were high due to the election.  I suppose they didn’t ramp up in Q4 due to the seasonal slowness.

    Regardless, this is a company with no moat selling commodity products.  If the bulls are correct and this company has brand equity, they NEED to defend it through aggressive ad spending.  When the company reports in 2 weeks either 1) we will see that they have increased ad spending and thus hurt their margins or 2) they have not increased ad spending and therefore their sales have suffered due to the growing competition.  As the CNBC anecdote illustrates I believe that option 1 is the more likely case.

    This is a company that has seen a steady decline in its business and is facing a more difficult future.  They have temporarily been trying to hide these facts by cutting an essential piece of their business model, yet currently trade at the highest multiples they have seen in 3 years (16.8x trailing PE).  It is also worth noting that the last time the stock saw similar multiples they had more than $50M in cash on their balance sheet, and now they have less than $20M, making a buyback announcement etc less likely.   

    Risks:

    Share holder friendly management

    Traditionally high ROE business

    Already high short interest

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

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