PETS - PetMed Express Still A 'Sell' But There Are Hopes For A Turnaround

2023-10-02 17:32:23 ET

Summary

• PetMed Express faces challenges from larger competitors and declining profitability.
• The company has a new management team and has made strategic investments, such as partnerships and acquisitions.
• These investments have led to positive revenue growth, but challenges remain, including high expenses and negative operating margin.

Introduction

PetMed Express, Inc. ( PETS ) is a nationwide pet pharmacy that markets prescription and non-prescription pet medications, health products, and supplies for dogs, cats, and horses directly to the consumer. The company faces a number of challenges in the current competitive landscape, including competition from larger players, such as Chewy ( CHWY ), Walmart ( WMT ), and Amazon ( AMZN ), as well as veterinarians. PetMed's profitability has also been declining in recent years.

However, there are some reasons to be optimistic about PetMed's future. The company has a new management team with experience in turnarounds and has made a number of strategic investments, such as its partnerships with Vetster and Pumpkin and its acquisition of PetCareRx. Yet, I think the degree of uncertainty is too high for considering a possible turnaround.

Business Overview

PetMed Express is a nationwide pet pharmacy that markets prescription and non-prescription pet medications, health products, and supplies for dogs, cats, and horses directly to the consumer. The company generates revenue by selling pet medications and supplies primarily to retail consumers.

PetMed Express was founded in 1996 and is headquartered in Pompano Beach, Florida. The company has over 20 years of experience in the online pet pharmacy industry and is one of the leading players in the market. PetMed Express offers a wide range of pet medications, including heartworm, flea, and tick preventatives, arthritis medications, antibiotics, and other specialty medications. The company also offers a variety of non-prescription pet products, such as flea and tick control products, bone and joint care products, vitamins, treats, nutritional supplements, and hygiene products. PetMed Express sells its products through its website and toll-free number.

In addition, the company has partnered with Pumpkin and Vetster to offer insurance services to its customers and to be the only health product provider for all Vetster's vets.

Competitive Landscape

Pure play retailers within the pet pharmacy industry, such as PetMed, compete primarily against veterinarians, who have the largest market share of a $13 billion market. According to PetCareRx (a recently acquired company by PetMed), health products are cheaper in online pet stores than in veterinarians' locations owing to the purchasing power, as online pet stores can get better discounts thanks to their scale than small vet hospitals, and overhead costs, as online pet stores are run with a lower number of employees relative to the number of products sold. However, since a while ago, the vet hospital industry has experienced a consolidation process . Thus, from my perspective, the survivor companies now have more purchasing power than in the past, which makes them more price competitive. Moreover, the arrival of Covetrus has allowed vets to sell health products with a slight premium over PetMed, according to Fund Letter Stock Ideas . Here, we need to remember vets offer a more convenient way to acquire the products than online retail; consequently, a minimum price difference won't deter customers from buying drugs from veterinarians. Moreover, the six largest suppliers accounted for 68.5% of all PetMed's purchases , which left PetMed in a disadvantageous bargaining position and vulnerable to changes in the purchase policies of those suppliers, which have already affected the company's profitability in 2022 .

Additionally, PetMed is competing with larger players, such as Chewy, Walmart, and Amazon. Thus, as PetMed is a smaller competitor, it can't offer the best discounts in the market, as the competitors mentioned above have a larger scale and greater access to better deals. So, PetMed is in a compromised situation, competing in a disadvantageous position compared to vets and other larger retailers. The competitive pressures have been noted in its financial performance. For instance, sales decreased by 16.93% since 2021, along with compressions in gross and operating margin; even the latest turned negative in the last year owing to increased SG&A expenses as a percentage of the sales.

Furthermore, the ROE and ROIC have tanked compared to the company's returns before the pandemic. Those high returns ended up bringing more competition to the market. Thus, PetMed didn't find a way to protect its high returns.

In my opinion, PetMed cannot compete effectively in this new market; it lost the first-mover advantage, and now larger players are conquering the industry together with tech-based companies, such as Covetrus, that are enhancing the logistics of veterinarians.

A Glimpse of Hope

Seeing the deterioration of financial performance, the board of directors appointed a new management two years ago, Matt Hulett , who has extensive experience in turnarounds. One of his successes was Rosetta Stone, an integrated learning platform supporting personalized math, English language arts, science, social studies, and Spanish learning, which was sold at an 86% premium to investors, transforming a zero-growth company into a double-digit growth company.

The new partnerships with Vetster and Pumpkin come from a strategic shift and are a way to increase cross-selling opportunities, gain new customers, and improve the customer experience (increasing convenience). For instance, Vetster is one of the fastest-growing pet telehealth companies, and now PetMed is the sole provider of Vetster.

On the same page, the acquisition of PetCareRx expands the portfolio of pet products offered by PetMed. However, I think food and supplies products should have a lower margin as those can be distributed and sold without any license.

Moreover, the AutoShip subscription program is another initiative that I believe increases comfort and enhances the value offered to customers; at the time, it slightly raises some barriers against competition.

In my opinion, those initiatives differ from the pricing competition (in which PetMed already cannot compete) by differentiating from other competitors, giving clients a better and more comprehensive offer.

These initiatives are paying off already, as in 1Q24 , PetMed experienced positive revenue growth of 11% YoY. Customers increased by 25% YoY, and the reorders by 7%.

Nevertheless, a cause of higher SG&A comes from an expansion in the Stock-Based Compensation in the last two years (since the inception of Matt Hulett) and the milestone of achieving 50% of revenue from AutoShip subscribers was delayed until FY2024, when the management believed it could reach the milestone in 2023. In 1Q24, 49% of the revenue came from the AutoShip & Save + PetPlus membership program. Besides, in 1Q24, the company recorded a negative operating margin.

Conclusion

PetMed Express, a nationwide pet pharmacy, faces several challenges. The company is competing with larger players, such as Chewy, Walmart, and Amazon, as well as veterinarians. In addition, PetMed's profitability has been declining in recent years. Despite these challenges, there are some reasons to be optimistic about PetMed's future. The company has a new management team with experience in turnarounds. PetMed has also made a number of strategic investments, such as its partnerships with Vetster and Pumpkin and its acquisition of PetCareRx. These investments have begun to pay off, as PetMed experienced positive revenue growth of 11% YoY in 1Q24. However, the company still faces several challenges, such as its high SG&A expenses and negative operating margin.

Consequently, I think there is not enough evidence to conclude the business is experiencing a turnaround; thus, it's a 'Sell' until the uncertainty decreases. Nevertheless, the current prices could be a bargain with considerable upward potential for high-risk-tolerance investors.

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