PETS - PetMed Express: I'd Take That Medicine (Rating Upgrade)

2023-07-21 22:32:52 ET

Summary

• PetMed Express shares have returned a loss of 27.7% over the past 5 ½ months, however, the shares are reasonably cheap and the dividend yield is attractive.
• Despite sales being down by $16.6 million compared to the previous year, the company remains profitable with a strong balance sheet and cash from operations spiking by $9.3 million.
• The stock is recommended to investors who can tolerate volatility to buy shares at current prices, as the business is expected to provide decent income even if the business goes flat.

It’s been about 5 ½ months since I published my latest cautious piece about PetMed Express Inc. ( PETS ) and in that time, the shares have returned negative 27.7% against a gain of 9.2% for the S&P 500. While I didn’t buy shares at $19.43, I did sell 10 of the September puts with a strike of $15 for $.80 each, so it’s likely that in a few months, I’ll become the proud owner of 1,000 of these shares at a net price of $14.20 each. I want to write about the financial history here before that happens in order to try to understand whether it will make sense to hold my shares or not. I’ll also review the valuation, obviously.

The weekend is finally upon us, and because of that, our schedules have suddenly become that much tighter. For that reason, you may not want to read an entire article. If that’s your circumstance, then no worries, because I’ve got a solution for you. The solution is this “thesis statement” where I instill the gist of my article into a single paragraph. This allows you to understand what I’m thinking without the need to read the entire document. You’re welcome. I’m not buying these shares at the moment because of my short put position here. Were it not for this, though, I’d be backing up the truck on these. I think the shares are reasonably cheap, and I think the dividend yield is very attractive. As importantly, I think the dividend is very well covered because of the large cash hoard, and decent free cash flow generation here. I’ve recently covered many stocks where the yield is below the risk-free rate. This one is unlike those others in that it’s on the other side of the risk free rate. I like getting compensated for taking on risk, and PetMed Express is a great way to do that.

Financial Snapshot

The financial picture here is a tale of two statements in my view. The income statement is fairly bad in my estimation. In spite of the fact that sales were down about $16.6 million relative to the previous year, net income absolutely collapsed by $20.9 million. There’s no “one off” item that we can blame this on. G&A, Advertising, and depreciation expenses increased by 60.5%, 3.3%, and 29.5% respectively. These three combined added an extra $20 million of expenses to the income statement. The capital structure, meanwhile, remains quite strong. The company has $104 million in cash at the moment, against total liabilities of $40.3 million. While I’ll admit that total liabilities are up by about $6 million from last year, I’m not concerned on this front. In spite of the recent uptick in expenses, the company remains profitable, and the balance sheet remains very strong. The strength of the balance sheet, coupled with the fact that cash from operations spiked $9.3 million, or 50.3%, suggests to me that the high yielding dividend is reasonably well covered here. Given that, I’d be willing to buy the stock at the right price.

The Stock

If you've read my stuff for a while, you know that I consider the stock and the business to be different things. The business generates money by selling pet medication. The stock represents an ownership stake in the business, but because it’s driven by the crowd, the price moves up and down more than what is reasonable in my estimation. In my view, the up and down price movements often reflect more about the mood of the capricious crowd than it does anything to do with the business. Additionally, when the crowd does react to what's going on at the firm, it often overreacts, and these overreactions are the source of potential profit, in my view.

To highlight this reality using this stock, let’s imagine there are two investors, each of whom decide to buy this stock based on the exact same level of awareness about what’s going on with the business. One buys on July 10, and is currently up about 5% over the past 11 days. The second person bought 9 days later, and they are down about 4%. Not enough happened at the firm to warrant a 9% change in return over two weeks. The stock really matters, and I only ever want to buy stocks when investors are relatively skittish.

Another word for "relatively skittish" is "cheap", which is why I really like buying cheap shares. I measure cheapness in a few ways, ranging from the simple to the more complex. On the simple side, I like to look at the ratio of market price to some measure of economic value like earnings, free cash flow, and the like. I want to see a stock trading at a discount to both the overall market and its own history. When I last reviewed PetMed Express, the PE was sitting around 25.4, which I considered to be excessive. Since earnings have collapsed, the PE has been blown out so it’s impossible to use this measure, so I’ll use price to free cash flow instead. On this basis, and on a price to sales basis, the shares look reasonably cheap at the moment, per the following:

Additionally, the dividend yield was previously not particularly attractive, at 4.55%, because it was only slightly higher than the risk free rate. The yield is now 8.85%, which is about 3.5% greater than the 1 year Bill, and fully 5% greater than the 10 year Note . Given that I think the dividend is reasonably well covered, this is fairly significant in my view. The significant yield allows the investor time to wait for the business to improve, and even if it turns into a cash cow, there are worse fates in the world than a sustainable, near 9% dividend yield.

Given the above, I would recommend investors who can tolerate some volatility buy the shares at current prices. Either the business is going to improve from here, in which case you’ll receive decent income and a nice capital gain, or the business will stagnate, in which case you’ll receive “only” decent income. As investors were told to seek risk adjusted returns, and I think the risk reward is very compelling here at current prices. While I won’t be adding myself because of my short put position, I think an investor who’s just coming to this party would do well to buy at current levels.

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