Why PetSmart's Sell-Off Is a Buying Opportunity

The Bureau of Labor Statistics reported last year that nearly three-quarters of all U.S. households own pets. In all, there are about 218 million pets in the United States. And it goes without saying that all those furry companions need food, grooming, and health care.

The amount of money Americans spend on their furry friends to keep them happy and healthy is truly shocking. On average, U.S. households spend around $500 apiece each year to care for their pets. In all, Americans fork over more than $61 billion on their pets every year.

Taking all of this into account, it looks like PetSmart should have no trouble pleasing Wall Street. But that's not what happened after it released its first-quarter earnings and outlook for the current quarter. In fact, PetSmart shares dropped 10% in the aftermath of its quarterly report because it missed analyst expectations.

Don't be too quick to show PetSmart the door. It's still growing profits, and the strong underlying tailwinds of the pet-care industry should provide plenty of future growth to come...once the short-term headwinds subside.

source: PetSmart website

PetSmart's earnings report was one for the dogs
PetSmart unveiled first-quarter results that were fairly good but weren't good enough to prevent investors from running for the exits. Earnings per share clocked in at $1.04, representing 6% growth. However, revenue growth totaled just 1%, and same-store sales, which measure sales at locations open at least one year, declined 0.6% year over year.

Even more disappointing was the company's top-line outlook for the second quarter and full year. PetSmart sees the possibility for same-store sales to fall again this quarter. For 2014, management expects flat same-store sales and total revenue growth only in the low single digits.

This represents a significant reduction in the company's prior forecast. Management previously expected 2%-4% same-store sales growth for the full year. PetSmart also cut its earnings projections for 2014. The company now expects to earn $4.34 per share this year, down from $4.48 per share previously.

There's no doubt PetSmart is seeing weakness in its customer base. Primarily, PetSmart believes consumers are pinching pennies more than usual, especially in light of the frustratingly slow economic recovery in the United States. In addition, it's likely the brutally harsh winter weather resulted in softness in the last quarter. But these issues look like minor bumps in the road rather than something more serious.

Execution is keeping PetSmart going
Despite tepid sales growth last quarter and weak expectations going forward, PetSmart is still solidly profitable and will remain so. That's because management is keeping a tight lid on expenses. PetSmart generates a 30% gross profit margin.

In addition, PetSmart is boosting earnings per share with its aggressive share- buyback program. Last quarter alone, PetSmart spent $130 million on share repurchases. These buybacks are effectively reducing the number of shares outstanding and creating value for shareholders.

Plus, even with its lowered profit forecast for the remainder of the year, PetSmart will still generate solid earnings growth. If it manages to hit the midpoint of its EPS guidance, the company will post 8% earnings growth in 2014 versus the prior year.

Bet on man's best friends
Normally I would be critical of a company achieving profit growth purely through cost cuts amid falling revenue. That's usually a red flag because sales are the lifeblood of any retailer. But the fundamental tailwinds of PetSmart's industry should alleviate those concerns.

As mentioned previously, Americans don't hesitate to shell out the necessary cash for the health and well-being of their furry friends. That's not going to change any time soon, unless of course people stop the age-old practice of domesticating animals. But that doesn't seem likely.

For that reason, PetSmart seems like a health-care play as much as a consumer- goods play. People can't simply stop buying their animals food, health care, and grooming products. That's why the slowdown currently affecting PetSmart should be short term in nature, and the recent sell-off looks to be a good opportunity.

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The article Why PetSmart's Sell-Off Is a Buying Opportunity originally appeared on Fool.com.

Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends PetSmart. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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