Over the past six months, Petco has been a great trade, beating the S&P 500 by 14.8%. Its stock price has climbed to $3.29, representing a healthy 31.6% increase. This performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Petco, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
We’re glad investors have benefited from the price increase, but we're swiping left on Petco for now. Here are three reasons why WOOF doesn't excite us and a stock we'd rather own.
Why Is Petco Not Exciting?
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.
1. Same-Store Sales Falling Behind Peers
Same-store sales is an industry measure of whether revenue is growing at existing stores, and it is driven by customer visits (often called traffic) and the average spending per customer (ticket).
Petco’s demand within its existing locations has been relatively stable over the last two years but was below most retailers. On average, the company’s same-store sales have grown by 1.7% per year.
2. Operating Losses Sound the Alarms
Operating margin is a key measure of profitability. Think of it as net income - the bottom line - excluding the impact of taxes and interest on debt, which are less connected to business fundamentals.
Although Petco broke even this quarter from an operational perspective, it’s generally struggled over a longer time period. Its expensive cost structure has contributed to an average operating margin of negative 9% over the last two years. Despite the consumer retail industry’s secular decline, unprofitable public companies are few and far between. It’s unfortunate that Petco was one of them.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Petco burned through $11.4 million of cash over the last year, and its $2.99 billion of debt exceeds the $116.7 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the Petco’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Petco until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
Petco isn’t a terrible business, but it isn’t one of our picks. With its shares outperforming the market lately, the stock trades at 72.7× forward price-to-earnings (or $3.29 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think there are better stocks to buy right now. We’d recommend looking at the Amazon and PayPal of Latin America.
Stocks We Like More Than Petco
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