The Exchange

PetSmart: The New Dog in Town on the S&P 500

Groomers are dazzling up dogs with bling, bows

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AP Photo/Richard Vogel

The dogs of the Dow are one thing -- now investors are about to welcome a new pooch to the S&P 500: major pet supply retailer PetSmart Inc. (PETM).

After market close Oct. 4, PetSmart, the largest U.S. retailer to cater strictly to the animal population, will find a new home with the index, replacing oil and gas company Sunoco Inc., (SUN), which will be acquired by Energy Transfer Partners L.P. (ETP) on that same day. PetSmart will be moving on up from its place in the S&P Midcap 400 index; it'll be replaced there by hunting and outdoor goods supplier Cabela's (CAB). The move was announced Monday.

We Love Our Pets

We all know Americans love their pets -- some of them obsessively. The latest statistics from The Humane Society state that at least 39%  of U.S. households own at least one dog, while 33% have at least one cat. And let's not forget the hamsters, birds, rabbits, fish, guinea pigs, etc. According to a recent article in the Financial Times, the $67 billion-a-year market for dog and cat food alone is quadruple that of baby food and twice that of the coffee market.  Along with pet chow  and the other "consumables," such as litter, that make up more than 50% of PetSmart's business, the company sells a serious selection of supplies and also also offers in-house services such as grooming, training and boarding.

The pet food and supply space is definitely a fragmented one, as competitors include everything from major supermarket chains and warehouse clubs to online outfits such as and local veterinary offices, but the privately owned Petco is its major direct competitor.

Wedbush analyst Joan Storms sees PetSmart's move to the index as "both a positive for the company and the stock," but she doesn't think it necessarily reflects a trend related to the overall pet industry. She does, however, feel that, "post-recession, the industry seems to have stabilized." There was  a decline in PetSmart's "hard goods" sales at the height of the economic downturn, she says, and this directly correlates to adoption rates. But "an improved macro environment should promote higher adoption rates and industry growth."

The big advantages in PetSmart's model, she says, as opposed to that of its competitors, are "limited distribution of higher nutrition content food and captive services businesses [such as the above-mentioned personalized hotel and grooming services]." These services help to offset the advantages of lower pet food and supply prices that giants such as Wal-Mart (WMT) and Target (TGT) can offer.

PetSmart, which has a market cap of $7.4 billion and has close to 1,200 store locations across the U.S., is trading up around 1% Tuesday afternoon, with shares at $68 and change. Shares have had a strong 2012, trading up 33% since January, and it's not uncommon for stocks to get a bit of boost from being added to an index that's mimicked by numerous mutual funds (more than $1 trillion is indexed to the S&P 500). Earnings in August came in at 71 cents a share, better than the 66-cents analyst consensus, and full-year guidance was also raised to a range of $3.30 to $3.40, compared with an earlier range of $3.19 to $3.31. Its revenue for the second quarter was $1.62 billion. This was the 16th beat of out 17 for the company's quarterly results going back four years.

And if you were an investor who bought in -- and held on -- when the company began trading at $10 a share in August 2003, you'd be up a cool 672% now. The stock's P/E ratio sits at 23, and its beta is at 0.58, which means it is less volatile than the market as a whole (stocks that have a volatility mimicking the S&P, for perspective, have a beta of 1).

It remains to be seen if higher times are ahead for the stock as PetSmart joins the large cap universe. Stay tuned after Oct. 4. But for now, tune into something that will always stand the test of time: "A very cute and funny dog video."

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