chicken_little_funny-t2Last week, PetSmart announced first quarter earnings. The company reported slowing growth and negative same store sales.  I believe it was the first negative comp quarter in 16 years for PetSmart. Management took full year comp store guidance down to zero, from 2%. The stock fell approximately 8% on the news, taking the year-to-date loss to -22%. Naturally, this has led some to question whether the sky is falling for PetSmart, the pet industry, or b0th.  To begin to answer these questions, we first need to uncouple them.

To assess the performance of PetSmart, separate and distinct from the industry, the best place to start seems to be in the context of broader retail.  Anyone who was surprised by softness in PetSmart’s numbers has probably not been keeping their pulse on the four wall retail environment. In January, 20 retailers pre-announced earnings shortfalls. This was the highest number post recession and on par with the levels the industry experienced in third and fourth quarter 2008. Howard Schultz blamed it on the Internet, others cited weather, consumer confidence, and wage stagnation. Notably, both Wal Mart (-0.4%) and Target (-2.5%) produced negative comps for the 1Q2014. We cataloged 1Q2014 revenue growth, EPS growth and performance versus guidance of some of the major big box retailers here — 1Q Retail EPS Performance. Notably, PetSmart was the only company within this comp group to exceed guidance on earnings. What this speaks to is the fact that PetSmart has a very good handle on the cost side of their business. While they experienced slight margin compression, unlike its peers PetSmart does not appear to be chasing the middle market consumer through a promotional discounting strategy. This underscores PetSmart’s relative market position in the industry as well as the ongoing attractiveness of the pet category.

When we shift our analytical purview to the broader industry, the cause and effect relationship is more apparent. While total consumer spending on pet products and services continues on a positive growth trajectory, total growth has been slowing, driven by a falling comps for pet products (see graph below).  What this demonstrates is that the industry is maturing and that drivers are changing.  As the pet food upgrade cycle has tapered products sales growth has slowed.  However, as a wellness focus has ascended, services revenue growth has accelerated.  Given that services is a much smaller part of PetSmart’s mix, it was bound to experience the malaise of the industry’s product sales growth trajectory.  PetSmart’s first quarter revenue growth was more or less inline with the growth in industry product sales.  Additionally, keep in mind that total pet industry sales, as measured by consumer expenditures by category, grew 12.6% between 2011 and 2013; at some point the “law of large numbers” catches up to everyone.Slide1A second lens we like to use to assess pet industry performance is the rate of adoptions.  An increase in ownership and multi-pet householders means an increase in expenditures.  However, as evidenced by the chart below, the growth rate for companion animal adoptions, as measured by shelters monitored by Pethealth, Inc., slowed markedly in 1Q2014, especially for dogs.  That said, a similar contraction was evident in 2011, a year of strong industry growth (4.7% according to the American Pet Products Association).  As such, we think it is too early to call it a year for the industry, but in combination with slowing pet products sales it is cause for some consternation.Slide2In looking at the total body of available data there is reason to be concerned about the pace of pet industry growth but not the overall health of the industry.  Slower growth has been anticipated and therefore should not come as a surprise. The industry has been defying skeptics for sometime, but all good things experience a tapering.  Further, it is too early to call the year from any analytical perspective.  The pet industry remains very attractive long term and while online players, adjacent market competitors, and emerging brands have eroded the leadership of both major retailers and product manufacturers, the threat to their overall industry position remains low.  Generally speaking, physical retail has experience a much more significant contraction, driven by share shift to mobile and online, recently even after you factor out the weather.  In that context one can view PetSmart’s performance in a relatively positive light.

I think I can say with authority, when it comes to all things pet there may be clouds in the sky, but it is not currently falling.

/bryan

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