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A Stock With 43% Upside -- Driven By An Extremely Loyal Market

Michael Vodicka

I love investing in companies that have strong emotional connections with their customers.

Starbucks (SBUX) is a great example. Starbucks has extremely loyal customers because of the warm atmosphere of its cafes, the reliable quality and convenience of its goods, and its emphasis on health and wellness.

Ancestry.com is the same way. The online genealogy service helps people track their family histories with a massive database of personal and public records. Ancestry's strong connection with its members has driven high renewal and growth rates.

Every company in the world wants a strong emotional connection with its customers, but that type of higher-level relationship is hard to come by -- and extremely valuable.

That's one of the biggest reasons why I like PetMed Express (PETS). The largest pet pharmacy in the U.S., PetMed sells prescription and over-the-counter pet medications and other health products for cats, dogs and other pets. But unlike traditional brick-and-mortar pharmacies, PetMed relies exclusively on its websites, television and direct marketing to sell its products.

As a leader in the pet pharmaceuticals industry, PetMed is banking on the powerful connection that owners feel with their pets. That bond continues to show up in the amount of money pet owners are investing in these relationships.

There are an estimated 165 million dogs and cats in the U.S., and about 62% of U.S. households have a pet, according to the American Pet Products Manufacturers Association. Spending on pets in the United States reached $53 billion last year, a 6% increase from 2011. Spending on OTC medications showed even faster growth of 7.4%, to $12.7 billion.

And that trend is expected to accelerate.

StreetAuthority analyst Joseph Hogue recently examined how aging baby boomers are expected to drive pet ownership rates: "The need for social involvement and connection leads many to pet ownership. Almost half (46%) of people over 65 have pets. If that percentage holds, by 2030 more than 33 million seniors will be caring for at least one pet."

That plays perfectly into the hands of PetMed Express, lifting shares to a 32% gain this year and an 85% gain over the past two years. Take a look at the big move below.

  © PetMed Express  
  Although PetMed is still in the early stages of long-term growth, the company is in position to cash in on the bullish trend in pet ownership rates and spending.


But PetMed is still in the early stages of long-term growth. The company is in position to cash in on the bullish trend in pet ownership rates and spending. It also has plenty of room to expand its product portfolio beyond pet medications and chip into the highly lucrative market of PetSmart (PETM), the pet supplies retailer with a market cap of $7.5 billion. PetMed will also benefit from its delivery services, catering to a demographic of customers with higher discretionary income and limited mobility.

In addition to organic growth, PetMed could also be a great takeover target for a large online retailer looking to dominate the pet pharmaceutical market. Wal-Mart (WMT) has already launched its own online pet pharmacy. But a merger with fellow online heavyweight Amazon.com (AMZN) would have incredible synergy and operational scalability for PetMed -- and put a large premium on its shares.

PetMed's strong financial profile -- $50 million in cash and equivalents and no long-term debt -- will likely enable it to invest in growth and reward shareholders. The led the company to increase its dividend by 13% in its most recent quarter, to a healthy 4.4%.

Risks to Consider: PetMed needs to expand its product portfolio in order to cash in on the fast-growing pet supplies market in addition to pharmaceuticals. There is also concern about Wal-Mart's entry into the pet pharmaceuticals space. Although growth is still strong, larger online retailers pose a threat.

Action to Take --> Trends in pet ownership and spending remain bullish. And PetMed Express is a great way to cash in. In spite of all the good news, shares still look undervalued, trading with a forward price-to-earnings (P/E) ratio of 16, a sharp discount to its peer average of 23. If PetMed carried that same forward P/E of 23, shares would jump to $22, a 43% premium from current levels.

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