PETS - PetMed Express: Another Tough Year

2023-12-11 17:20:38 ET

Summary

• PetMed Express Inc. continues to struggle, with the stock price declining by about 66% since January 2022.
• The company's customer acquisition costs remain challenged due to intense competition.
• PetMed Express' performance remains weak and the stock should be avoided.

PetMed Express, Inc. (PETS), a DTC pet pharmacy and online provider of prescription and non-prescription medications and other products, continues to struggle. My previous coverage , in January 2022, outlined why investors should avoid the stock and since then shares have declined by about 66% including dividends. The two sticking points were that 1) the company's customer acquisition costs were out of control due to competition and 2) a turnaround wasn't in sight to justify its valuation at the time.

In the past two years, TTM net sales have declined from $284 million in late 2021 to $270 million today, due to declining reorder sales and new order sales. Pulling from the Q2 2024 earnings call transcript , CEO Matt Hulett stated a key challenge: "And while this decline is less than it was a year ago, we have not yet achieved a stabilized returning customer base." Broadly, PETS is facing an onslaught of competition, including larger peers with more aggressive marketing, greater budgets, pricing alternatives, etc.

PETS stabilizing its sales and gross margin this year was largely driven by its acquisition of PetCareRx, which is great, but it involved a total cash consideration of $36 million. According to Forbes, PetCareRx would bring about $42 million in revenue, or an 0.85x sales multiple. That's quite a premium with PETS at .57x and Chewy ( CHWY ) at 0.76x today, however, management anticipates meaningful growth from this acquisition.

That said, PETS underlying topline and margin profile probably would have been even pretty weak without this acquisition. Moreover, about $20.7 million in goodwill was added to the balance sheet, which represented more than half the purchase price. Finally, customer acquisition costs [CAC] broadly continue to move in the wrong direction as well. In its fiscal period ended September 30, 2022, its CAC was around $64 and has reached $73 in September 30, 2023. The trend was stable on a six-month basis at $79 year-over-year. Regardless, the business has officially pushed into operating losses on an EBIT basis (though managing to eke out positive EBITDA in Q3).

All in, the acquisition certainly helps stabilize PETS' performance but it came at a significant cost. Another strategic decision, which I think is much easier to agree with, was management's suspension of the dividend. Of course that would not be well received by the retail investing crowd and potential exclusion from dividend-focused funds, but it ultimately buys management time to fix its marketing strategy. Testing better marketing tactics to reduce its CAC will probably be the difference of whether the business can retain sales and do so profitably. Although not a direct customer of PETS myself, common practice strategies that work include targeted and recurring email campaigns, price match discounts, loyalty programs, buy 1 get 1 item free, etc.. However, competitors are doing the very same thing, and Chewy, for example, continues to operate at breakeven profitability. Of course, other less expensive tactics can go a long way, but I'm not here to go on about how the company should fix its marketing strategy. Point being, PETS needs to achieve organic and sustained sales growth, or I believe it could otherwise be facing down a classic death spiral.

Operating losses are something PETS hasn't seen in over 20 years and now it holds about $53.5 million in the bank. Liquidity isn't a concern, especially with the suspended dividend. However, share-based compensation is approaching $7 million annualized for 2023, which should arguably decline in light of the company's recent poor performance.

Using very rough numbers here, PETS market capitalization and enterprise value were around $500 million and $400 million, respectively, when I first wrote up the company. Now, its market cap and enterprise value have fallen to about $150 million and $100 million, respectively. So the market is essentially pricing in that the company's historical profit margins are a way of the past, are terminally lower, and so far the turnaround strategy doesn't have me all that convinced. Sell-side analyst participation on the conference calls are also, unsurprisingly, dwindling.

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