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PetMed Express Is a Buy

- By Jonathan Poland

Spending on pet health care in the U.S. is expected to reach $70 billion by 2020 and PetMed Express (PETS) is the very best small-cap trade.

PetMed has a market capitalization under $500 million and while it may be a slow-growth story, the company remains America's largest pet pharmacy with much more room to expand in the market. By some counts, the number of dogs and cats owned as pets in the U.S. is close to 200 million.

More importantly, pets are treated as well as children with the majority of owners not willing to cut spending on their pet in tough times. Heartworm medication cost dog owners an average $102 per year, while cat owners paid out $65 per year. At PetMed, the average order is around $87. Multiply that figure by the 90 million dogs and 95 million cats Americans keep as pets, and PetMed Express has a long way to go and a lot of growth ahead.

More importantly, people are only doing more and more for their pets. I mean, we don't just have a day, we have an entire week for dogs. Why are people buying homes with yards now? Their dogs.

As for PetMed, the company has gone from earning $23 million on $219 million in sales in 2009 to earning $43 million on $286 million in the last 12 months thanks to share buybacks and stronger operating margins. This has helped it build a solid book value ($6.28 per share) without spending a lot on capex. The company also pays out a sizable dividend: 97 cents per share, with a projected yield north of 4.6% next year.

These metrics are only getting better over time, and PetMed is expected to earn over $2.25 by 2020, which puts its forward price-earnings multiple at 10.5x, a big deviation from its historic average, which is close to 20x. In fact, PetMed is trading right now at historical lows in terms of its own price multiples and at a discount against the industry and S&P earnings multiple.

If PetMed does earn $2.25 per share, and investors realize the error of this valuation, and put it just halfway back to its historical average, at 15x earnings, the stock would price in the $34 range, a 40% gain.

Bottom line: It's a bargain.

Disclosure: I am not long or short PetMed .

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This article first appeared on GuruFocus.