Recently, we downgraded our recommendation on PetMed Express (PETS) to Neutral. After a solid start in fiscal 2014, PetMed posted an unimpressive second quarter performance with earnings lagging behind our expectation. Although better-than-expected revenues remain as an upside, increasing product costs and discounts laid huge pressure on margin. This nationwide pet pharmacy presently carries a Zacks Rank #4 (Sell).
Why the Downgrade?
PetMed reported earnings per share of $0.21 in the second quarter of fiscal 2014, a penny short of the Zacks Consensus Estimate. However, the figure remained 3.0% up on a year-over-year basis. Net sales in the quarter increased 4.0% year over year to $60.5 million, beating the Zacks Consensus Estimate by a whisker.
Increasing product costs and discounts continued to take a toll on the company’s gross margin. During the reported quarter, gross margin contracted 148 basis points (bps) year over year to 31.8% due to increasing product costs and discounts. On the other hand, a 2.5% rise in general and administrative expenses and a 5.9% drop in advertising expenses supported a 2.4% reduction in operating expenses (without depreciation). Yet, adjusted operating margin contracted 13 bps to 11.2%.
Meanwhile, the company continues to face competitive pressure in the hugely fragmented pet medications market. The dearth of any major near-term catalyst might make it difficult for PetMed to overcome these challenges in the near future.
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