PetSmart (PETM) Shares Up on Rumored Buyout Talks

by Ryan Fitzwater, Director of Research, The Oxford Club
Rich Frenchbulldog

Yesterday PetSmart (Nasdaq: PETM) reported mixed quarterly results. Sales were unimpressive but profits did jump. I’ll have more on that in a moment. The main reason shares are surging higher today is due to continued talks surrounding the company being taken private in the near future.

PetSmart has been under pressure from major shareholders Jana Partners and Longview Asset Management Partners to cut costs. As a result, in August it started exploring “strategic alternatives.”

This lead PetSmart to establish a profit improvement program that looks to cut costs by $200 million per year by 2016. It also started talks surrounding the potential sale of the company.

Today’s price surge can mostly be attributed to reports that Clayton, Dubilier & Rice and KKR & Co. (NYSE: KKR) have teamed up to take the company private for a price tag of $7.5 billion. That represents a $190 million premium to PetSmart’s market cap as of yesterday’s close. Sources say that the joint bid could be submitted in December.

And the auction seems to be heating up.

BC Partners and Apollo Global Management (NYSE: APO) are also rumored to be gearing up to make an offer.

Company officials haven’t confirmed or denied these claims, but if PetSmart is taken private, it would be the largest leverage buyout of the year.

A Mixed Bag of Quarterly Results

PetSmart’s recent quarterly results weren’t exactly stellar. Net sales jumped 2.6% over the same period last year to $1.7 billion. But the company had 51 more stores in operation to start the quarter compared to the same quarter last year. And at the close of the quarter, a total of 73 more stores had come online.

And same store sales (sales at stores that have been open for at least one year) were flat for the period.

The company saw a 2.4% decrease in transactions that were offset by an average ticket increase of 2.4%. In laymen’s terms, the number of PetSmart visitors decreased but those who came in spent 2.4% more.

Analysts look at same-store sales (also known as S.S.S or comps) frequently in the retail industry. It is an important metric to gauge since a company can boost sales just by opening several new stores. It helps us differentiate revenue growth that comes from new stores versus growth that is a result of improved operations and management at already existing establishments.

Now you can see why PetSmart’s 2.6% increase in sales with 51 more stores in operation at the beginning of the period is nothing to clap about.

However, it was able to boost profits (adjusted for non-recurring costs) to $1.02 per share compared to $0.88 in the same period last year, a 15.9% increase. The “non-recurring cost” is related to the company’s profit improvement program. Earnings of $1.02 per share also beat consensus estimates of $0.95 for the quarter.

The profit improvement program and quarterly results have been under the microscopes of takeover bidders ever since PetSmart announced it was exploring a potential sale.

But speculation around a takeover is what it is … speculative. For now, current and potential investors have to weigh minor net sales growth, flat same sales growth, recent quarterly results and the company’s current financial health against a possible takeover.

We can quickly gauge PetSmart’s financials with our Investment U Fundamental Factor Test. If a decent rating shakes out, it could be a good time to take on new/more shares and hope for further developments in takeover talks.

Earnings-per-Share (EPS) Growth: As you already know, EPS jumped 15.9% this quarter excluding a one-time cost. And even if you included the one-time cost, EPS still increased 4.5% for the period.

Price-to-Earnings (P/E) Ratio: PetSmart’s P/E of 17.20 is slightly below the industry average of 18.67. Not overwhelming cheap on an earnings basis, but still discounted compared to its peers.

Debt-to-Equity Not overleveraged here. PetSmart’s debt-to-equity of 42.07% is more than for times lower than the industry average. Potential takeover bidders have to be happy about that portion of the balance sheet.

Free Cash Flow per Share Growth : Unfortunately, free cash flow dropped 3.6% this quarter. Nothing major, but we want to see growth.

Profit Margins PetSmart’s profit margins of 5.3% are double the industry average of 2.49%.

 Return on Equity PetSmart’s ROE is a healthy 34.83%. In comparison, the industry average is 12.36%. Management is doing a great job on this metric.

*Why did we look at these specific metrics? Find out more here.

Fundamental Factor Test Score

A: Strong Buy (Hits five or more key metrics)

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