Recently, we reiterated our Neutral recommendation on PetMed Express (PETS) with a target price of $11.00.
PetMed reported a 5% decline in revenues during the most recent quarter affected as it was by aggressive pricing in flea and tick products and introduction of generic Frontline to the market. Although the company decided against participating actively in the generic flea and tick market due to a pending litigation, it expects to be actively involved in 2012, which should improve revenues.
The company also added 184,000 new customers compared with 185,000 in the year-ago period with a $3 year-over-year decline in the average order size to $76. However, the company believes that with completion of one year of price cuts in the flea and tick market, the situation should improve next year.
Advertisement expenses were down as the company was not satisfied with the response rates which resulted in a $3 decline in the cost to acquire a customer to $43. To address the challenges in the advertising space, the company is banking on better efficiency and creativity to differentiate itself from others.
PetMed exited the reported quarter with cash and cash equivalents of $47.1 million, marginally down from $49.6 million at the end of March 2011, but what is more important, without any debt. The company repurchased approximately 894,000 shares during the quarter for $9 million and was left with $15 million of authorization. The 8.9% year-over-year decline in outstanding shares also benefited the bottom line.
However, PetMed continues to witness challenges with respect to declining margins. Gross margin declined 230 basis points (bps) year over year to 34.2% primarily due to lower sales on the back of more aggressive pricing while cost of sales remained flat.
Operating margin also declined 210 bps to 11.03% despite lower operating expenses. Although advertising expenses declined in the reported quarter, the company expects to increase it in the forthcoming period. Consequently, we expect the decline in margins to persist in the coming quarters.
PetMed offers a wide range of products for dogs, cats, and horses. The company markets its products primarily under well-known brands of medication such as Frontline Plus, K9 Advantix, Advantage, Heartgard Plus, Sentinel, Interceptor, among others. We nevertheless remain concerned about the intensely competitive scenario facing PetMed with the presence of peers like PetSmart (PETM).
The stock retains a Zacks #3 Rank (Hold) in the short term.
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