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This Market Leader Has Soared 345% Since 2008 -- And Could Still Double

TimBegany

If you were a kid in the 1970s and '80s like I was, then you may have noticed just how much better household pets generally have it these days.

Years ago, pets were more often treated like disposable possessions. People often acquired them without thinking much about how to keep them safe or healthy. And once the novelty of having them wore off, they were often cared for grudgingly, ignored, or simply gotten rid of. But today, people are much more likely to pamper their pets and treat them like indispensable family members.

As a result, the pet products and services industry has become enormous. Total spending on pets in the U.S. should top $55 billion this year, up from about $51 billion in 2011. It has nearly doubled during the past 10 years.

With a 40% market share, one leading pet products and services company has taken major advantage of this trend. Since 2004, its sales have grown 8.5% annually and more than doubled, from $3 billion to $6.8 billion. 

Not even the Great Recession could slow this company down much, suggesting its customers are highly loyal and tend to see pet-related spending as non-discretionary. During the past five years, sales maintained nearly an 8% growth rate. Meanwhile, the price of the company's stock rose from about $16 to $73 a share -- an increase of 345% and an annualized rate of return of 35%.

The company I'm referring to is PetSmart (Nasdaq: PETM). And even though its stock has run up so much, I think it's still got lots of growth potential left to offer.

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  Flickr/Random Retail  
  Since 2004, the company's sales have grown 8.5% annually and more than doubled to $6.8 billion.  

First of all, PetSmart is hands-down the biggest player in its industry, with twice the market share of its closest competitor, privately held Petco, which accounts for only 20% of industry sales. What's more, the pet ownership rate in the U.S. is projected to keep rising by 2% annually, which would bring that rate to nearly 70% of all U.S. households in 2018. Analysts estimate industry sales will keep expanding by 4% a year, reaching nearly $67 billion five years from now.

I expect PetSmart will more effectively capitalize on these trends than Petco and other competitors not just because it has the largest market share but because it's maintaining the strategy that vaulted it to the top spot in the first place. That strategy includes offering the widest variety of pet products and services, maintaining exclusive rights to many products, focusing on top-quality brands, and emphasizing customer service.

By sticking to that game plan, PetSmart has established itself much like Whole Foods Market (Nasdaq: WFM) has in the grocery store business -- as a provider of premium products and superior service. As a result, it too has built a base of affluent customers who are willing to keep paying more for its products and services in good and bad economies. The company estimates household income for the typical PetSmart customer is 30% greater than average and that PetSmart customers spend nearly 80% more on their pets than the typical pet owner.

Currently, pet food, treats and other consumables generate 53% of revenue. Thirty-four percent of sales are from "hard goods" such as collars, leashes, carriers and bedding. Services (like grooming and training) and small pet sales account for 11% and 2% of revenue, respectively. In the coming decade, analysts expect sales to climb 7% a year, to nearly $14 billion in 2023.

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However, services and medications are the fastest-growing categories. Analysts project annual revenue increases in the high single digits or low double digits for both categories in coming years. (My colleague Joseph Hogue profiled another pet medications company, PetMed Express (Nasdaq: PETS), in his "Graying of America" series this summer.)

Consensus estimates are for earnings per share to rise 15% a year from just shy of $4 now to just over $8 in five years. If the stock's price-to-earnings P/E ratio remains in line with the historical average, the price could jump into the $150 range by 2018. That would be about twice the current price of about $73 a share. 

Risks to Consider: PetSmart may dominate the pet food and supplies industry, but it's in a constant war for market share with discounters, warehouse clubs and grocery stores. Such intense competition could erode sales and profits.

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Action to Take --> Despite PetSmart's long run-up, its P/E ratio is still only 18.4 -- slightly below its historical average of 18.6 and the S&P 500 Index's 18.7. Now, I certainly don't see PetSmart as a value stock at current prices, but I would be comfortable buying it now because it's so well positioned to outperform.

Of course, many investors worry a correction is imminent because the bull market has endured for so long and done so in a shaky economy. If you think stocks may tank soon, consider waiting to buy PetSmart until shares pull back. Since there's no guarantee of a correction, you could also split your investment, buying some shares now and picking up more later if a correction occurs.

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