ropeadopeIn 1974, while fighting George Foreman, of The Foreman Grill fame, in Zaire (now the Democratic Republic of Congo) (aka “The Rumble in the Jungle”), Muhammad Ali pulled off arguably his greatest upset.  Few thought Ali could take down the larger and younger Foreman.  However, Ali, whose career had been defined by a direct attacking style featuring consistent foot and head movement, had a trick up his sleeve.  That trick involved Ali laying on the ring ropes, employing limited, if any, movement, for most of the initial rounds, allowing Foreman to punch him in the body.  As Ali rested on the ropes, most of the brunt of Foreman’s punches were absorbed by the ring structure, as opposed to Ali.  After a few rounds, Foreman began to tire from the endless exertion, despite inflicting limited damage to his opponent.  In the fifth round, Ali returned to his direct style and was able to easily dominate the wilting Foreman.  The rest, as they say, is history.

The strategy Ali employed became known as the “rope-a-dope”, a phrase coined by publicist John Condon.  As I listened to PetSmart’s 1Q2013 earnings call, I could not help but to think management was doing to me what Ali had done to Foreman.  To achieve the full effect of the parallel, we need a bit of a history lesson first.

During the past three years we have come to expect impressive performance from PetSmart.  As the pet industry entered the limelight post recession, the company was its poster child.  As the pet population resumed positive growth and as consumers entered into a seemingly endless upgrade cycle, PetSmart’s performance and public equity valuation took off.  Over the past three years, PetSmart has grown faster than the industry by 2.6% (2010), 2.4% (2011) and 5.0% (2012).  As a result, its equity price has exceeded the return S&P 500 by (round numbers) 18% (CY 2012), 29% (CY 2011) and 37% (CY 2010).  For this corresponding period, PetSmart produced same-store-sales growth of 6.4% (FY 2012), 5.4% (FY 2011) and 4.8% (FY 2010).  Comps were supported by strong growth in average ticket size and solid traffic numbers.  Earnings ballooned from $1.59 (fully diluted) per share in FY 2010 to $3.55 (fully diluted) per share for FY 2012.   So it came as a surprise to many, myself included, when, earlier this year, the company proffered a sanguine view of forward performance — same store sales growth of 2% – 4% versus 5% consensus and earnings growth of 10% – 12% versus 15% consensus.  The news sent the stock plunging.  At some level PetSmart had become a victim of its own success as this forward projection would be enviable by any specialty retailer.  Add in a poorly communicated management succession with some channel creep (see here — https://bryanjaf.wordpress.com/2013/02/04/has-petsmart-peaked/), and bearish sentiment started to creep into the minds of many pundits, including myself.

So, when PetSmart announced 3.5% same-store-sales in 1Q2013, an acceleration of the two year comp trend from 5.1% to 5.5% and steadying traffic trends, many were surprised.  I was surprised. Management then did what it has in the past, raised guidance for the year.  For someone reading the tea leaves by tracking monthly personal consumption expenditures on pets through the Bureau of Economic Activity, which showed 5% growth in February and March, or Nielsen data that showed consumables accelerating by 4.6% in 1Q2013, PetSmart’s numbers should not have come as a shock.  Effectively, management had rope-a-doped us (actually they have been doing it for a long time, beating the high end of guidance 11 of the past 20 quarters), re-setting inflated expectations to more reasonable levels and then used what would be otherwise be viewed as modest numbers by the specialty retailer to ignite positive momentum in the company narrative.  In the process, they set aside the concerns about management and the internet in one earnings call, saying our core business is going to do just fine.  Analysts responded with upgrades and higher price targets for the stock.

While I remain cautious on PetSmart’s ability to continue to buck the trend long term, the quarter was settling to me and re-framed my focus on what matters — how is the core industry participant responding to the current economic environment as it relates to pet, as opposed to vexing over the company’s ability to respond to leading edge groups like GenX and Hispanics who appear to be changing their purchasing behavior.  Net net, the near term outlook appears solid but I maintain steadfast in my belief that PetSmart and its core competitors will need to evolve their model to maintain share long term in a world of increasing mobile commerce, proliferation of venues for pet product availability, and a consumer who is focused on pet health and wellness.

Congrats to PetSmart’s management, they pulled one over on me.  I got rope-a-doped, no question about it.

/bryan