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Petco's (NASDAQ:WOOF) Q1 Sales Top Estimates, Stock Soars


Full Report / May 22, 2024

Pet-focused retailer Petco (NASDAQ:WOOF) reported results ahead of analysts' expectations in Q1 CY2024, with revenue down 1.7% year on year to $1.53 billion. The company expects next quarter's revenue to be around $1.53 billion, in line with analysts' estimates. It made a non-GAAP loss of $0.04 per share, down from its loss of $0.01 per share in the same quarter last year.

Petco (WOOF) Q1 CY2024 Highlights:

  • Revenue: $1.53 billion vs analyst estimates of $1.51 billion (1.1% beat)
  • Adjusted EBITDA: $75.6 million vs analyst estimates of $69.0 million (9.6% beat)
  • EPS (non-GAAP): -$0.04 vs analyst estimates of -$0.06
  • Revenue Guidance for Q2 CY2024 is $1.53 billion at the midpoint, roughly in line with what analysts were expecting (adjusted EBITDA and EPS (non-GAAP) guidance for next quarter also roughly in line)
  • EPS (non-GAAP) Guidance for Q2 CY2024 is -$0.02 at the midpoint, above analyst estimates of -$0.02
  • Gross Margin (GAAP): 37.8%, down from 38.9% in the same quarter last year
  • Free Cash Flow was -$41.06 million compared to -$24.4 million in the same quarter last year
  • Same-Store Sales were down 1.2% year on year
  • Market Capitalization: $660.5 million

Historically known for its window displays of pets for sale or adoption, Petco (NASDAQ:WOOF) is a specialty retailer of pet food and supplies as well as a provider of services such as wellness checks and grooming.

Since its 1965 founding, the company has evolved from largely a place where consumers could buy or adopt pets such as dogs and fish to a one-stop shop for current and potential pet owners. A cat owner can buy Merrick cat food made from natural ingredients, a dog owner can buy Frontline flea and tick collars, and an aquarium owner can buy Tetra water filters. Additionally, services are available at Petco. Cats can be groomed, dogs can undergo parasite treatments, and small pets such as rabbits can undergo diagnostic tests.

Petco store sizes can vary, but most are 10,000 to 20,000 square feet. They tend to be located in shopping centers and retail plazas that get regular foot traffic. Most stores tend to dedicate the largest percentage of floor space to pet food and supplies such as toys and grooming products, separated by type of animal. There are then special aquatic sections with fish tanks and service areas for pets to be groomed and treated for minor ailments. Most Petco stores partner with local animal shelters or rescue organizations to facilitate adoptions of various animal types.

Specialty Retail

Some retailers try to sell everything under the sun, while others—appropriately called Specialty Retailers—focus on selling a narrow category and aiming to be exceptional at it. Whether it’s eyeglasses, sporting goods, or beauty and cosmetics, these stores win with depth of product in their category as well as in-store expertise and guidance for shoppers who need it. E-commerce competition exists and waning retail foot traffic impacts these retailers, but the magnitude of the headwinds depends on what they sell and what extra value they provide in their stores.

Competitors that offer pet products and services include Chewy (NYSE:CHWY), Tractor Supply Company (NASDAQ:TSCO), and Academy Sports and Outdoors (NASDAQ:ASO) as well as private companies such as PetSmart.

Sales Growth

Petco is larger than most consumer retail companies and benefits from economies of scale, giving it an edge over its competitors.

As you can see below, the company's annualized revenue growth rate of 8.8% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was mediocre despite closing stores, implying that growth was driven by higher sales at existing, established stores.

Petco Total Revenue

This quarter, Petco's revenue fell 1.7% year on year to $1.53 billion but beat Wall Street's estimates by 1.1%. The company is guiding for a 0.4% year-on-year revenue decline next quarter to $1.53 billion, a reversal from the 3.4% year-on-year increase it recorded in the same quarter last year. Looking ahead, Wall Street expects revenue to remain flat over the next 12 months.

Same-Store Sales

Same-store sales growth is a key performance indicator used to measure organic growth and demand for retailers.

Petco's demand within its existing stores has been relatively stable over the last eight quarters but fallen behind the broader consumer retail sector. On average, the company's same-store sales have grown by 2.4% year on year. Given its declining store count over the same period, this performance stems from higher e-commerce sales or increased foot traffic at existing stores, which is sometimes a side effect of reducing the total number of stores.

Petco Year On Year Same Store Sales Growth

In the latest quarter, Petco's same-store sales fell 1.2% year on year. This decline was a reversal from the 5.1% year-on-year increase it posted 12 months ago. We'll be keeping a close eye on the company to see if this turns into a longer-term trend.

Gross Margin & Pricing Power

We prefer higher gross margins because they make it easier to generate more operating profits.

Petco's unit economics are higher than the typical retailer, giving it the flexibility to invest in areas such as marketing and talent to reach more consumers. As you can see below, it's averaged a decent 38.5% gross margin over the last eight quarters. This means the company makes $0.38 for every $1 in revenue before accounting for its operating expenses.

Petco Gross Margin (GAAP)

Petco's gross profit margin came in at 37.8% this quarter, marking a 1 percentage point decrease from 38.9% in the same quarter last year. One quarter of margin contraction shouldn't worry investors as a retailer's gross margin can often change due to factors such as product discounting and dynamic input costs (think distribution and freight expenses to move goods).

Operating Margin

Operating margin is a key profitability metric for retailers because it accounts for all expenses keeping the lights on, including wages, rent, advertising, and other administrative costs.

In Q1, Petco generated an operating profit margin of negative 1.1%, down 2.9 percentage points year on year. We can infer Petco was less efficient with its expenses or had lower leverage on its fixed costs because its operating margin decreased more than its gross margin.

Petco Operating Margin (GAAP)

Unprofitable publicly traded companies are few and far between in the consumer retail sector, and over the last two years, Petco has been one of them. Its high expenses have contributed to an average operating margin of negative 8.3%. On top of that, Petco's margin has declined, on average, by 23 percentage points year on year. This shows the company is heading in the wrong direction, and investors were likely hoping for better results.

EPS

Earnings growth is a critical metric to track, but for long-term shareholders, earnings per share (EPS) is more telling because it accounts for dilution and share repurchases.

In Q1, Petco reported EPS at negative $0.04, down from negative $0.01 in the same quarter a year ago. This print beat Wall Street's estimates by 35.2%.

Petco EPS (Adjusted)

Between FY2020 and FY2024, Petco's adjusted diluted EPS dropped 99.9%, translating into 83% annualized declines. In a mature sector such as consumer retail, we tend to steer our readers away from companies with falling EPS. If there's no earnings growth, it's difficult to build confidence in a business's underlying fundamentals, leaving a low margin of safety around the company's valuation (making the stock susceptible to large downward swings).

On the bright side, Wall Street expects the company's earnings to grow over the next 12 months, with analysts projecting an average 99.5% year-on-year increase in EPS.

Cash Is King

If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe in the end, cash is king, and you can't use accounting profits to pay the bills.

Petco burned through $41.06 million of cash in Q1, representing a negative 2.7% free cash flow margin. The company reduced its cash burn by 68.3% year on year.

Petco Free Cash Flow Margin

Over the last eight quarters, Petco has shown mediocre cash profitability, putting it in a pinch as it gives the company limited opportunities to reinvest, pay down debt, or return capital to shareholders. Its free cash flow margin has averaged 0.2%, subpar for a consumer retail business. Furthermore, its margin has averaged year-on-year declines of 1.3 percentage points.

Return on Invested Capital (ROIC)

EPS and free cash flow tell us whether a company was profitable while growing revenue. But was it capital-efficient? A company’s ROIC explains this by showing how much operating profit a company makes compared to how much money the business raised (debt and equity).

Petco's five-year average ROIC was negative 0.6%, meaning management lost money while trying to expand the business. Its returns were among the worst in the consumer retail sector.

Petco Return On Invested Capital

The trend in its ROIC, however, is often what surprises the market and drives the stock price. Unfortunately, Petco's ROIC significantly decreased over the last few years. Paired with its already low returns, these declines suggest the company's profitable business opportunities are few and far between.

Balance Sheet Risk

As long-term investors, the risk we care most about is the permanent loss of capital. This can happen when a company goes bankrupt or raises money from a disadvantaged position and is separate from short-term stock price volatility, which we are much less bothered by.

Petco's $2.98 billion of debt exceeds the $89.72 million of cash on its balance sheet. Furthermore, its 8x net-debt-to-EBITDA ratio (based on its EBITDA of $365.7 million over the last 12 months) shows the company is overleveraged.

At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Petco could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.

We hope Petco can improve its balance sheet and remain cautious until it increases its profitability or reduces its debt.

Key Takeaways from Petco's Q1 Results

We were impressed by how significantly Petco blew past analysts' EPS expectations this quarter. We were also glad next quarter's revenue, adjusted EBITDA, and earnings guidance were roughly in line with Wall Street's estimates, showing that the company remains on track with no surprises. Zooming out, we think this was a solid quarter that should please shareholders. The stock is up 8.5% after reporting and currently trades at $2.67 per share.

Is Now The Time?

Petco may have had a good quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

We cheer for all companies serving consumers, but in the case of Petco, we'll be cheering from the sidelines. Its revenue growth has been mediocre over the last four years, and analysts expect growth to deteriorate from here. And while its projected EPS for the next year implies the company's fundamentals will improve, the downside is its declining EPS over the last four years makes it hard to trust. On top of that, its relatively low ROIC suggests it has struggled to grow profits historically.

While we've no doubt one can find things to like about Petco, we think there are better opportunities elsewhere in the market. We don't see many reasons to get involved at the moment.

Wall Street analysts covering the company had a one-year price target of $2.92 per share right before these results (compared to the current share price of $2.67).

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