SINGULAR
DILIGENCE
NOTES
PetSmart (NASDAQ:PETM)
Overview
PetSmart: Does a Cheaper Price Suggest a Narrowing Moat?
10 years growth
169%
106%
32%
Sales
Earnings
Enterprise Value
Enterprise value didn’t increase much despite 169% earnings growth
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Supermarkets once dominated the pet food market
o 95% market share i
o Specialty players failed to break the dominance of supermarkets
 Including Petco
Supermarket’s dominance started to weaken in the mid-1980s
o Part of the cause for the change was the emergence of “warehouse”
discount stores and “superstores”
Jim and Janice Dougherty opened the first store of their new company
o The Pet Food Warehouse
o In 1987
o The store was 25,000 square feet
o In Phoenix, Arizona
o It was the first high volume, low-priced pet store in the U.S.
o The Pet Food Warehouse was incorporated in August 1986 ii
 Using $1 million start-up investment
• From Phillips-Van Heusen Corporation, and
• Other investors
 Opened 2 stores in 1987
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 Received more money from venture capitalists after the first 2
stores
• Opened 5 stores in 1988, in
o Arizona
o Colorado, and
o Texas
 The 7 stores performed well
• $16 million sales
• But didn’t make money
o Lost $1.8 million in 1989
o => The board of investors removed the Doughertys
Samuel Parker was hired as chairman of the company
o In 1989
o He was a 19-year veteran of the Jewel supermarket chain
 Also had served as president of
• Frame-N-Lens Optical
• GEMCO division of Lucky Stores
Samuel Parker refined the Doughertys’ concept iii
o Transformed the money-losing Pet Food Warehouse into PETsMART
 More hospitable environment for customers
• Cement floors were replaced with tile floors
• Aisles were widened
• In-store lighting was brightened
 Add more pet accessories and supplies
 Beat competition by
• A far greater selection of products iv
o 7,000 pet-related products
o Supermarkets carried 800 items
o Warehouse clubs carried 20 items
o A mass merchandise store carried 500 items
o A traditional pet store carried 1,000 items
• At substantially lower prices
o 10-30% below competitors
 Added services
• Grooming
• Veterinary centers
• Adoption service called ‘Luv-a-Pet’
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PETsMART started to expand
o Had in total
 1989: 12 stores
 1990: 29 stores
 1991: 48 stores
o From 1989 to 1993
 Annual sales growth was 85%
• 1989: $15.9 million
• 1990: $29.3 million
• 1991: $58.2 million
• 1992: $106.6 million
• 1993: $188 million
o $2.4 million net income
 Became the largest operator in the industry
o During this time, Petco started to transform its stores into “superstores”
 12,000 to 15,000 square feet
PETsMART went public in 1993
o Yielded $125 million
o Allowed PETsMART to further expand
PETsMART complemented organic growth with some acquisitions
o Pet Food & Supply
 In 1993
 Based in Phoenix
 5 stores
o Petzazz
 1994
 $50 million sales
 Gave PETsMART entry into the Chicago market
 PETsMART paid $81.3 million stock swap
o Petstuff
 Based in Atlanta
 PETsMART’s closest rival
• With 56 stores
o Pet City
 A U.K. chain
 50 superstores
 $214 million in a stock swap
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o PETsMART later exit the U.K. business
 At a loss of $46 million
PETsMART ended 2000 with 533 stores
PETsMART works hard to differentiate from competitors
o Changed the format in 2000 v
 Stores have a warmer environment
• Bright colors to distinguish various sections
• More visual emphasis on services
 Reduced shelf inventory
• => more open and visually appealing layout
• Added more distribution centers to replenish stores more
often
o Added day care and hotels vi
 4000-7,500 square feet
 A hotel has vii
• 75 to 90 regular guest room
• 5 to 8 suites
• Two to three play rooms to support the Day Camp
business
• Other features, amenities, and services
 Change the name from PETsMART to PetSmart viii
• MART get PetSmart to the commodity of the world
• Smart get into the total lifetime care
o Invested total $1.2 billion in advertising since 2000
o Services revenue grew 18% annually since 1999
 1999: $76 million
 2013: $766 million
o A PetSmart store today
 12,000 – 18,000 square feet
 In power centers
• Draw customers within 5-miles radius
 An additional 1,500 square feet for a Banfield hospital
 Carries a wide selection of pet food and supplies
• 11,000 items
• Carries from widely distributed brands to channel-exclusive
brands
o Example of dog food brands
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o Widely distributed brands
 Pedigree
• About $0.5 per pound
 Beneful
• About $0.8 per pound
 Purina One
• About $1 per pound
o Channel exclusive brands
 Purina Pro, Hills’ Science Diet
• About $1.2 per pound
 Eukabana
• About $1.5 per pound
 Nutro Ultra, Innova, Nature’s Recipe
• About $1.8 per pound
 Hills’ Ideal Balance
• About $2 per pound
 Blue Buffalo, Wellness, Royal Canin
• About $2.5 per pound
• Pet supplies has a lot of human brands like
o Martha Stewards
o GNC
o Disney
o Etc.
o PetSmart get exclusive license for these brands
 Pet adoption services
• Found homes for approximately 440,000 pets in 2013
• Found homes for over 5 million pets since 1994
 Grooming
• About 900 square feet
• Grooming is done with dogs on raised tables
• The grooming section has glass around instead of wall
• => people can see
 Hotel
• 4,000 to 7,500 square feet
PetSmart is the price leader
o Follows everyday low price strategy
o PetSmart price is
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 5-7% above mass retailers ix
 8-10% below specialty competitors and groceries
o PetSmart is the original pricer x xi
 Set price reference for others
Big scale allows PetSmart get over 40% return on capital
o Gross margin is about the same as other people
 30%
o But earn 10% profit margin
 Specialty stores average 3.6% profit margin
o Asset turns over is about 4.4
o => 44% return on capital
PetSmart has been gaining market share
o In food & supplies
 2006: 12%
 2013: 17%
o In services:
 2006: 9%
 2013: 16%
PetSmart can continue gaining share
o Sell services to merchandise customers
o Services help get new customers to the stores
The pet industry has great future prospect
o Expects to grow at or slightly above GDP growth rate
Over the last 10 years
o PetSmart grew sales 8.3% annually
 Operating profit grew 11.7% annually
• Thanks to margin expansion
• Service sales has higher margin
o But EV increased by only 30%
 $4,249 million in 2004
 $5,622 million today
• At $58 per share
The two top concerns are
o Competition from supermarkets and mass retailers
o Online competition
Are these concerns legitimate?
“Petco had been operating as a retailer of pet food and supplies for nearly 30
years before the company launched its bid to become the dominant national
player in its industry. Founded in 1965, the company competed during its
first decades as one of the hundreds of regional pet merchandisers
scattered across the country who found it difficult to operate under the
shadow of the all-powerful supermarkets. In the battle to lure pet owners into
their stores, the supermarkets prevailed comfortably, accounting for 95 percent of
all the pet food sold in the country. Their dominance came at the expense of
specialized retailers like Petco, but beginning in the mid-1980s
the stifling grip maintained by the supermarkets started to weaken. The
cause for the change was part of a pervasive transformation of the retail
industry as whole in which massive "warehouse" discount stores and
"superstores" secured a substantial foothold in the retail sector. Along with
the growing prominence of these new retail formats, the diversity of pet products-particularly food--increased, providing a lucrative niche for the specialized
retailers to exploit. Supermarkets had held sway by stocking their shelves
with popular brands such as Alpo, Kal Kan, and Purina, but beginning in
the mid-1980s new premium brands of pet food were introduced into the
market. Premium brands such as IAMS, Science Diet, and Nutro that
offered higher levels of nutrition than the supermarket brands became
increasingly popular among pet owners, and specialized pet products
stores were the only retailers to carry such brands. The changing dynamics
of the pet products industry led to the decreasing strength of the supermarkets
and the growing prominence of retailers such as Petco. Between the mid-1980s
and the mid-1990s, the percentage of pet food sold in supermarkets slipped
from 95 percent to 50 percent, with specialized pet products retailers,
warehouse clubs, and mass merchandisers accounting for the change. The
conditions were prime for Petco's growth and expansion into a national chain. In
the reshaping of the pet products industry, the nearly 30-year-old regional retailer
played a leading role.” – Petco’s history, http://www.answers.com/topic/petcoanimal-supplies-inc#ixzz33V7ONN10
i
ii
“In 1987, a new concept in retailing pet food was born when Jim and
Janice Dougherty opened the first store of their new company, The Pet
Food Warehouse. As its corporate title suggested, The Pet
Food Warehouse sold huge bags of pet food in a large, sparsely decorated,
cement-floored store, giving consumers the opportunity to purchase food for their
pets in bulk at discount prices. The warehouse retail concept was not new at
the time, but it was the first time the high-volume, low-priced approach of
retailing products to consumers had carried over to the pet industry, a
roughly $7 billion-a-year industry during the mid-1980s that was dominated
by supermarkets and mass merchandisers, with myriad small pet stores
snatching what little was left. The Doughertys, however, were intent on adding
a new type of competitor to the industry, one that could take advantage of a
burgeoning trend among consumers during the 1980s and fuel the growth of their
fledgling enterprise.
Jim and Janice Dougherty incorporated their company in August 1986,
using $1 million in start-up investment from Phillips-Van Heusen
Corporation and other investors to open their first two stores in Phoenix,
Arizona, the following year. Venture capitalists continued to fund the company's
expansion after the first two stores were established, providing the financial
support to establish five additional stores by 1988 in Arizona, Colorado, and
Texas, as The Pet Food Warehouse began to take on the qualities of a retail
chain. Although there was evidence that The Pet Food Warehouse was
performing well--seven stores had been established in less than two years,
and annual sales had risen to nearly $16 million--there was one important
financial statistic that tinctured its success, particularly in the minds of the
company's all-important investors: the regional chain was losing money. In
1989, The Pet Food Warehouse lost $1.8 million, prompting the group of
investors supporting the company to make a dramatic change. That year, the
board of investors voted for the removal of the Doughertys, retaining the
two founders as consultants but excluding them from direct control over
the company they had started less than two years earlier.” – PetSmart’s
history, http://www.fundinguniverse.com/company-histories/petsmart-inc-history/
iii
“Although the Doughertys were gone, the concept of selling pet supplies in a
large retail store at discount prices remained alive, at least in the hearts of the
investors who still hoped The Pet Food Warehouse approach could yield a return
on their investments. To replace the Doughertys, the company's financial
supporters wanted someone with more retail management experience, and in
Samuel J. Parker they gained a leader with considerable experience. A 19-year
veteran of the Jewel supermarket chain, Parker also had served as president of
Frame-N-Lens Optical and the GEMCO division of Lucky Stores, accruing
sufficient executive management experience to attract the attention of The Pet
Food Warehouse's anxious controlling investors.
Parker was hired as chairman of the company shortly after the removal of the
Doughertys in 1989, and he immediately began to exert his managerial control
over the seven-unit chain. Although the Doughertys had originated
the warehouse retail concept in the pet supply industry, Parker's refinement
of the concept would produce the results for which antsy investors hoped,
and he soon transformed the money-losing Pet Food Warehouse into
PETsMART, Inc., one of the fastest growing companies of any kind in the
United States during the early 1990s.
Once Parker was brought on board, sweeping changes were made: cement
floors were replaced with tile floors, aisles were widened, and in-store
lighting was brightened, creating a more hospitable environment for
customers. Instead of merely selling pet food, Parker stocked the
company's stores with a full array of pet accessories and supplies,
attempting to beat the competition by offering a far greater selection of
products at substantially reduced prices. What emerged early under Parker's
reign was a hybrid version of the concept first developed by the Doughertys, a
retail approach that incorporated the design of a warehouse store with the more
conventional trappings of a retail store. In the rear of a PETsMART store, pet
food was sold in austere surroundings; pet accessories were displayed on
retail racking in the front, giving the customers who frequented each
location the benefits of both worlds. In addition, Parker established
grooming and veterinary centers at PETsMART stores and then set up a pet
adoption service called 'Luv-a-Pet,' creating a one-stop pet store that
offered services and supplies even the largest mass merchandiser or
supermarket could not match.” – PetSmart’s history,
http://www.fundinguniverse.com/company-histories/petsmart-inc-history/
“Prices at the company's 25,000 square-foot units are "typically 10 to 30
percent below those of traditional pet food and pet supply outlets," he
reports. Product selection is extensive, with items carried ranging from collars,
leashes, and health aids, to toys, animal carriers, and equestrian supplies. In
fact, a Petsmart unit offers 7,000 pet-related products, as compared to "an
average of 800 such items in a typical supermarket, 20 in a typical
warehouse club, 500 in a typical mass merchandise store, and 1,000 in a
traditional pet store," says a spokesperson.” – Smart Moves at PETsMART,
Discount Merchandiser, September 1993
iv
“The retailer is happy so far with results from its reformatted stores, which group
products by how pet owners shop. Spokeswoman Lynn Adams said, the existing
formats are arranged by product type rather than pet type; for example, dog and
cat food in the same section rather than adjacent to other dog and cat
merchandise.
v
In the new format, pet owners can purchase every kind of product for their pet in
one area. Stores in markets such as Chicago, which won't be fully converted until
next year, have already begun an incremental migration to the new format,
according to one manager.
The new stores have a warmer environment, with bright colors to
distinguish various sections and more visual emphasis on services, Adams
said. No longer treated as an adjunct to the core business, pet training classes
will be moved from the sidelines to their own centrally located, cordoned-off
space in the store where they can clearly be seen by shoppers.
Another significant change already underway is a decline in shelf
inventory; steel shelving will eventually be eliminated throughout the
stores. PetsMart has added four forward distribution centers to the two that
had been supplying stores throughout the United States, helping to cut
shelf inventory for a more open, visually appealing layout, Adams said.
"We'll supply our stores more often with products that move quickly and
are most in demand," she added.” – PETsMART Spruces Up Sales with
New Services, Improved Store Format, Katherine Hutchison, DNS Retailing
Today, 18 June 2011
vi
“Today, the inside of the store looks a lot homier, with a little blue shingled area
inside with brick and siding that houses the hotel and day care area. Inside the
hotel section, visitors are greeted to slate tiles and wooden reception desk. In the
dog area, owners can choose between regular boarding, where dogs congregate
in a big room and then sleep alone in kennels, or private suites with raised
platform beds and televisions airing the Animal Planet cable network and other
pet programming. Since the stores are in strip malls, the company developed a
porous pebble floor where the dogs could urinate. There's also a "bone phone"
that allows owners to call in and talk to their pets. Cats have quarters with
separate air filtration systems so their smell doesn't drive the dogs crazy. The
cats also get to watch a live fish tank.
Francis says he can add a pet hotel to an existing location for less than half
the cost of building a similar standalone location. Plus, the hotel shares the
cost of the heating and air conditioning system, parking lot, employee
break area, armor car pickups, and other overhead. Overnight stays start at
$21 a night, $31 for a suite. Day care starts at $14 a day. After five years the
hotels can help boost a store's sales by 29% and double its profitability, both
because the hotels are a high-margin business and because customers come
more frequently and buy other things when they do. A typical PetSmart store
with a hotel earns $879,000 on sales of $7.1 million.
Even with numbers such as those, Francis says he's rolling out the hotel
concepts slowly. They're in just 62 of the stores today, although Francis
says they could ultimately be in 435 stores, or 40% of the chain, by 2010.
He's taking it slow because "people get angrier about bad service than a
bad product. It's more personal. We have to make sure we get it right."” –
The Battle to Be Top Dog, Christopher Palmeri, Business Week, 05 August 2007
“The Hotel's impact on the store four walls profitability remains consistent and
compelling. We now believe that the Hotel adds 29% to the total revenues of
the store and boosts pretax income by 99%, and drives 440 additional basis
points of pretax margins. Every Hotel has a Day Camp business folded in and
we have seven stores operating Day Camps without a Hotel attached. We have
looked at these two types of businesses and it's clear while the Day Camp is a
good business on its own, it's much more interesting when it's attached to a full
PetsHotel. So we're pursuing a high grade concept that gives our customers the
best of both worlds and fulfills Day Camp's customers' demand for Hotel
services. This new concept is between 5,000 and 5,500 square feet versus
the 7,200 square feet that we have in our traditional hotel. It has between 75
to 90 regular guest rooms and five to eight suites. In addition, it has two to
three playrooms to support the Day Camp businesses. While the lobby is
scaled-down, it offers all the same services, features and amenities as a full
PetsHotel. We're testing this hybrid model in one store in Dallas and we plan to
extend this test to an additional store this year. While it's early in the test, we'll
have the benefit of operating Hotels and Day Camps. We have had the benefit of
operating Hotels and Day Camps for four years. So we feel quite confident in the
potential of the new and slightly condensed version of the PetsHotel. While
overall revenues are lower in the smaller facility, investment costs are also
less. So the profitability of a 5,500 square foot PetsHotel is comparable to a
regular PetsHotel. And because the smaller version requires substantially
less square footage, we can put it into more potential store sites and more
markets. Because this hybrid model is so compelling, we think it can effectively
replace the stand-alone in-store Day Camps that we have planned, with better
revenues and increased profitability. So as we open more Hotels and better
understand the market potential, we now believe that the total buildout is 435
Hotels, well up from our original projection of 300. Of those, about 65% will
be in new or relocated stores, with the remainder in existing stores.” – Robert
Moran, former COO, John Rice 2006 Conference
vii
“On the new advertising campaign, we've done extensive focus groups to look
at, in a sense, the differentiation of the brand, who we are and how we stick out
in the pet specialty world and we came out very strong from the point of view of
viii
moving and emphasizing the SMART. The MART really gets us into the
commodity of the world. The SMART really gets us into the total lifetime
care. We have used our ad agency, Leo Burnett, to really help with us that, and
they have a great track record, especially in retailing with this type of creative
effort. So we are really looking forward to kicking this off on September 7.” – Bob
Moran, former COO, 2005 Q2 Earnings Call Transcript
ix
“store. Overall, on average, PetSmart is 8% to 10% less than the other pet
specialty retailers as well as grocery and we are within 5% to 7% of max prices.”
– Joe O’Leary, head of merchandising, 2011 Investor Day
“We, too, have heard some manufacturers talking about price increases on the
food side of the business. We think we are the price leaders for some, and
we're a price reference, at least, for several others.
x
We are ones who do our own original pricing off our own original algorithms and
what we understand about our own elasticities. That means in, I guess, more
simple terms that we price product off what it costs. So when stuff costs more we
do keep an eye on competitors and are vigilant in that regard, but the base case
here is that we price product based upon its cost and what we understand about
our own elasticities.
When we had price increases, I guess it was about two years ago, and now, the
behavior then was we priced our, we essentially pass through the prices and
after a short amount of time, the rest of the world, broadly speaking, passed
through as well, and competitive positions in that time were pretty much
maintained at slightly higher price points. I can't speculate what this time will
happen, but we'll price our product off the cost you pay for it then be vigilant as
we look at the competitive environment.” – Phil Francis, former CEO, 2005 Q3
Earnings Call Transcript
“What Tim said, yes. And remember, we're what I would call original pricers. We
don't go after name 'em minus some or somebody else plus some, we're one
who has our own price elasticity by subcategory, by competitor. The goal is to
optimize cash gross margin in the subcategory, and it just turns out that when
people do studies we're about 3 to 5 less expensive , or 10 to 17 -- 3 to 5 more
expensive than some and 10 to 17 less expensive than others. But as we do our
price optimization studies, if that told us the customer had moved and we should
move, those numbers would change. But we get there out of our own numbers,
not because we look at somebody else and use a calculator to do either a
fraction or a 1 point something or other calculation. We do original pricing. I'm not
xi
sure there's many of us left.” – Phil Francis, former CEO, 2005 Q4 Earnings Call
Transcript
Moat
PetSmart: The Biggest Fish in a Big Ocean
3%
11%
17%
PetSmart
Mass Retailers
Grocery
23%
Online
All Other
46%
PetSmart hold 17% market share of the $33 billion pet product market
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Market share
o Product market
 According to Nielsen 2012 Homescan Customer Panel data
• PetSmart: 17%
• Mass retailers: 46%
• Grocery: 23%
• Online: 3%
• All others: 11%
 According to America Pet Products Association (“APPA”)
• The pet product market is $33.71 billion
o Food and treat: $21.57 billion
o Pet supplies and medicine: $13.14 billion
• PetSmart merchandise sales excluding pets: $6 billion
o => 17.3% market share
o Service market:
 According to America Pet Products Association (“APPA”)
• The service market excluding veterinary care is $4.41
billion
• PetSmart’s services sales was $766 million
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o 17.4% market share
 According to PetSmart’s 2013 investor day presentation
• PetSmart’s services hold 16% market share
o Excludes training
 Compete mainly with tiny private competitors
o Vet care market
 According to America Pet Products Association (“APPA”)
• Vet care market was $14.37 billion in 2013
• Banfield sales was $1 billion
• => 7% market share
o PetSmart dominates the specialty market
 According to IBIS World March 2014
• Pet specialty market was $16.5 billion
o PetSmart: 40.3% market share
o Petco: 19.5% market share
• Share within the pet specialty market by category
o Pet food: 52%
 $16.5 * 0.52 = $8.58 billion
o Pet supplies: 29%
 $16.5 * 0.29 = $4.785 billion
o Pet services: 13%
 $16.5 * 0.13 = $2.145 billion
o Live animal: 6%
 16.5 * 0.06 = $0.99 billion
• There are 13,156 players
o 59.1% of players are nonemployers
 Stores without paid employees
o 83% of players have fewer than 5 employees
o Only 7.8% of total operators have more than 20
employees
PetSmart and Petco have advantages over independent stores
o Scale
 Independent stores buy from distributors
• Can’t get product at as low price as PetSmart and Petco
 Advertising
• PetSmart spent about $140 million in 2013
o Only 2% of sales
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o In 2001
 $80 million
 3.2% of sales
• 83% of specialty competitors have fewer than 5 employees
o They can’t do much advertising
o PetSmart’s profit margin is almost 3 times higher than industry average
 According to IBIS World March 2014, pet specialty’s average
profit margin is 3.6%
 PetSmart’s 2013 EBIT margin is 10%
o As a result, independent stores focus on ultra-premium foods
 Sells brands that are not available in big boxes
• Like Orijen dog food
PetSmart has some difference with Petco
o PetSmart has bigger stores
 PetSmart’s traditional store is 20,000 square feet
• Today PetSmart’s store ranges between 12,000 and
18,000 square feet
o 12,000-square-foot stores are for new locations i
• Average square feet per store
o 2005: 26,211 square feet
o 2013: 22,270 square feet
 Petco store is between 12,000-15,000 square feet
• Average square feet per store
o 2005: 14,449 square feet
o PetSmart is in “power centers” ii
 Petco in neighborhood strip mall
• Petco started as neighborhood stores
o 3,500 square feet
o Only started building big 12,000-15,000 square-foot
stores in early 1990s iii
 1992
• Small stores: 161
• Superstores: 37
 1993
• Small stores: 132
• Superstores: 76
 1994
• Small stores: 107
• Superstores: 132
 1995:
• Small stores: 79
• Super stores: 207
 1996:
• Small stores: 58
• Super stores: 278
 Petco is strong in the Northeast and California iv
 PetSmart tends to have better locations than Petco v vi
o PetSmart focuses more on services vii
 Petco focuses more on supplies
• In 2005:
o 30% of Petco’s sales was from dog and cat food
o 67.5% of Petco’s sales was from pet supplies and
small animals
o 53% of PetSmart’s sales was from pet supplies and
small animals
• From 1995 to 2005, Petco’s gross margin increased
steadily
o 1995: 23.8%
o 2005: 33.4%
• The improvement in gross margin was thanks to Petco's
focus on selling more pet supplies viii
 Petco stores have limited vet services at a number of stores ix
• Routine vaccinations
 Petco stores don’t have hotels
• Petco purchased Pooch hotels
o Has 10 hotels
o PetSmart has similar number of stores like Petco, but double sales and
the number of employees
 Number of employees
• PetSmart: 53,000 employees
o 26,000 full-time employees
• Petco: 23,000
 Sales
• PetSmart: $6,917 million
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• Petco: $3,227 million
PetSmart well differentiates from supermarkets & Wal-Mart
o Focuses on different customers x
 These customers give a special trip to buy pet products
 PetSmart is actually close to Target/Wal-Mart or other big box
o Differentiation
 Food
• Little overlap xi
o Less than 17% of sales overlap
o Less than 10% of SKU overlap
• 75% of sales are channel-exclusive xii
o But these products are available online xiii
 Services
• Knowledgeable staffs
• Customers can walk in with pets
o 25% of customers walk with pets
o Pet-centric atmosphere xiv
• Services
o Grooming
o Training
o Kennels
o Etc.
PetSmart is the price leader
o Follows everyday low price strategy
o PetSmart price is
 5-7% above mass retailers xv
 8-10% below specialty competitors and groceries
o PetSmart is the original pricer xvi xvii
 Set price reference for others
The supply side is well organized
o Top pet food companies by revenue in 2011 are
 Mars Petcare: $16,162 million
• Cesar, Whiskas, Pedigree, Nutro, Royal Canin
 Nestle Purina Petcare: $10,403 million
• Alpo, Dog Chow, Puppy Chow, Beneful, Purina One,
Purina Pro Plan
 Hill’s Pet Nutrition: $2,175 million
• Hill Science brand
 P&G Petcare: $1,802 million
• Iams, Eukanuba
 Del Monte Foods: $1,784 million
• Kibles n’ Bits, Meow Mix, Canine Carry Outs, Nature’s
Recipe
 Mars Petcare acquired P&G Petcare in 2014
 The biggest pet food companies are big consumer product
companies
• These companies has strong distribution capability with the
mass channel
• They have a lot of brands for the mass channels
• They also have premium brands in the specialty channels
o Royal Canin
o Nutro
o Hill Science
o Nature’s recipe
o Eukanuba
o Purina Pro Plan
 Price is lowest among premium foods
 Purina One is available at Wal-Mart
o Smaller manufacturers
 Blue Buffalo
 WellPet
• Wellness brand
o New manufacturers don’t have distribution capability with the mass
channel
 => Sell through independent stores
• Sell through distributors
• Consolidation of distributors make it harder for new
manufacturers today xviii
o 3 companies control 40% of the pet distribution
facilities in the U.S.
 Animal Supply Co.
 Philips Pet Food & Supplies
 Central Pet Distribution
 Position as ultra-premium food producers
-
o These companies are loyal to each channel
 If a ultra-premium brand moves from independent stores to mass
stores, it will be dropped immediately by independent stores xix
 Foods are differentiated by channels
• People equate good/premium with
o High price
o Smaller package
o Specialty outlet
o Small manufacturer
o More natural
o Changes happen only when a premium brand is acquired xx xxi
o But that would only benefit PetSmart
 Ultra-premium brand can go to PetSmart
 Premium brands wouldn’t go from PetSmart to the mass
• Only Iams went to the mass
o That happened when P&G acquired a pet food
company
o P&G has distribution strength with the mass
 P&G wanted to get exposure to the mass
 Result: xxii
• Get wide distribution
• Lower margin
• Assortments reduced
 Today, big consumer products companies already have exposure
to both mass and specialty channels
PetSmart has strength in services
o PetSmart gained share in service market
 2006: 13.9%
• According to APPA
o 2006 pet market was $38.5 billion
o Services were 7%
 $2.695 billion
 PetSmart services sales was $374 million in
2006
 => 13.9%
• According to another source, PetSmart’s market share was
9% in 2006 xxiii
-
 2013: 17%
o PetSmart has advantage in advertising over local competitors
o PetSmart has advantage in getting new pet owners to use services
 People go there to buy food and see there are grooming, hotel
services
o Grooming
 Labor intensive
• May not enjoy scale advantage
• But PetSmart can have high volume to keep groomers
busy
 PetSmart provides a decent cut for half the price at local
professional groomers xxiv
o Hotel
 Competes with small competitors xxv
• Best Friends is an East Coast oriented chain
o Freestanding hotels
o 40-50 hotels
• Most competitors are mom-and-pop
o Has one or two hotels
 Enjoys great scale advantage
• ½ CapEx of freestanding hotel
• Share costs of xxvi
o Heating and air conditioning system
o Bathroom
o Parking lot
o Employee break area
o Armor car pickups
o Other overhead
Customer habit is attractive
o Smart with Heart customers
 13% of customers
 51% of sales
 Average 17.8 transactions per year
 Average annual spend: $657
 => Average spend per transaction: $37
o Smart customers
 48% of customers
-
 41% of sales
 Average 4.1 transactions per year
 Average annual spend: 150
 => Average spend per transaction: $36.6
o Mart customers
 39% of customers
 8% of sales
 Average 1 transaction per year
 Average annual spend: $34
o Purchase frequency is not high enough for a budget item
o Price is not high enough to shop around
PetSmart was able to gain share overtime
o PetSmart gained share within specialty market
 According to IBIS World March 2014
• PetSmart market share
o 2008: 37%
o 2013: 40.3%
o Specialty market gained share from mass channel
 Mass market share xxvii
• 2011: 47%
• 2013: 46%
 Grocery market share
• 2011: 25%
• 2013: 23%
 Supermarket lost share overtime
• From mid-1980s to mid-1990s, supermarket market share
reduced from 95% to 50% xxviii
o 23% in 2013
 Mass brands like Purina, Alpo, Friskies and Kalkan lost share
overtime
• 1996: 75% of U.S. pet food sales
• 2000: 67% of U.S. pet food sales
• 2005: 62.1% of U.S. pet food sales
o The best chance to gain share is to
 Cross-sell services to existing customers
 Get people to stores for services
• Then cross-sell foods
-
 Get new pet parents
• Partner with PetSmart Charities
o Assist in saving the life of homeless pets
• Provide in-store adoption program
o Found homes for approximately 440,000 pets in
2013
o Found homes for over 5 million pets since 1994
• Get 2X for market share when a pet is adopted at
PetSmart xxix
• Vendors sponsor adoption events xxx
o A vendor sponsor 20,000 pets
 Hope the pets stay with their foods
 => $100 million life time value
• New pet owners may go to PetSmart because
o They want to buy premium food or use services
 Humanization of pets continues
o The brand is strong
• Younger generations are more likely to shop at big
boxes xxxi
If there’s any threat to PetSmart, it’s online competition (see Durability)
“UNIDENTIFIED AUDIENCE MEMBER: Could you guys talk a little bit about
when you're deciding where to put your new stores, can you talk about the
dynamics of the market that you look at? I know that you're looking at some
smaller store formats, and can you just talk about population, square footage,
product assortment, that type of thing?
i
DAVID LENHARDT, PETSMART CEO: Yes, sure. So, beginning last year our
mix of stores was about 65% of our stores were a smaller concept or smaller
box, roughly 12,000 to 13,000 feet, probably an extra 1,500 feet if it has a
Banfield in it. And this year, 65% of our stores will be that format versus our
more traditional 20K format. What that allows us to do is that allows us to,
one, keep the customer proposition. So, it still has grooming, it still has all
the same SKUs that we have in our more traditional box, and there are
fewer facings, but it still looks and feels like a PetSmart store, very little
difference. So, we can go to market as a PetSmart, and it allows us to go to
markets where you really couldn't make a 20 work from a rent perspective.
So, it's lower rents both on a rate perspective as well as lower rent in
totality because of the sheer smaller square footage. I would tell you that
from a pro forma perspective, as we reviewed those, that the returns on those
are there to four times what we were doing with our vintages in '07, '08 vintages,
and maybe some in '09. The best way I can describe it is those stores are
going into markets that are what I would characterize as tractor supply-like
markets, so it's in smaller fringe of the suburbs, smaller populations. We do
have them in some small towns, Grand Isle, Nebraska, Hot Springs, Arkansas,
Beckley, West Virginia. So, those are pretty small markets and we're pretty
excited about those just from a returns perspective. And now we're into our first
fully year, we're looking at the ramps and they seem to be holding everything we
thought they were going to do.” – Bank of America Merrill Lynch 2012
Conference
“Petco's stores tend to be smaller and more ubiquitous, almost replacing
the neighborhood pet store. They're located in strip malls. PetSmart stores
are bigger and tend to be in the larger "power centers," alongside other
discount chains. According to a recent analysis from JPMorgan (JPM) retail
analyst Nancy Hoch, PetSmart's prices were on average 8% higher than those of
Wal-Mart Stores (WMT), but 11% below Petco's.” – The Battle to Be Top Dog,
Christopher Palmeri, Business Week, 05 August 2007
ii
iii
Petco 1996 10-K
“This is a part of the country where I think PetSmart is more on the defensive.
We have the better locations, but there are more PetCo stores. We have to
fight harder for our piece of the dedicated pet store shopping trip.” – A
PetSmart’s regional manager in the Northeast, Blueshift Research
iv
“In the specialty channel, things get interesting. We have about as many
stores in this metro area as PetCo; only, ours are better clustered around
the city center, the big shopping districts. The PetCo locations are out
anchoring various suburbs and are more of a hard ‘destination shopping’
sort of weekend trip.” – A PetSmart’s regional manager in the mid-Atlantic,
Blueshift Research
v
“Locally we have PetCo but as a junior competitor. We were here before
them and had our pick of locations. Then we have Pet Supermarket tiptoeing
around our southern border and Pet Valu hugging their mid-Atlantic stronghold to
the north.” - A PetSmart’s regional manager in the Southeast, Blueshift
Research
vi
vii
“GROSS-OUT PETS. Petco has a different approach. The $2.2 billion
company still does two-thirds of its business in dog and cat products, but Petco
features a broader selection of goods for other animals, everything from
hamsters to tarantulas. The company recently featured a "Reptile Rendezvous"
at 200 stores. The events included "in the terrarium" photo contests and
demonstrations for products such as a new clay that reptile owners can mold into
small hills and caves. Snakes, iguanas, and turtles remain very popular with
teenage boys, says Petco's CEO James Myers: "Anything that grosses your
parents out."
Petco has not embraced the services strategy quite as aggressively as
PetSmart. Its stores do prominently feature grooming services, and the
company provides doggie day care at some locations. But Petco stores, at
about 14,000 sq. ft., aren't as large as PetSmart and for now Myers is
holding back on overnight pet-sitting. "I'm not sure that plays everywhere
in America," he says.” – The Battle to Be Top Dog, Christopher Palmeri,
Business Week, 05 August 2007
“Gross profit as a percentage of net sales increased to 33.2% for fiscal 2003
from 31.2% in the prior year period. The increase was driven partly by the
continuing change in mix from lower-margin premium pet food sales to
higher-margin categories such as pet accessories, supplies and services,
which accounted for an increase in gross profit of 0.9% of net sales.” –
Petco 2003 10K
viii
“We offer obedience training in most of our stores, grooming in the majority of
our stores and limited veterinary services, such as routine vaccinations, at a
number of stores.” – Petco 2006 10K
ix
“DAVE LENHARDT, CEO: I would say the overall environment continues to be
pretty stable, I think. Let me start with mass and the grocers. Over the last five,
six years, we have seen, from a market share perspective, continued share
shift away from the mass and the grocers into the pet specialty channel
,and I think that is continuing. I think that increasingly our overlap with the mass
is decreasing. I think our customer overlap, it's a very different customer
base. I think the mass guys may be competing against each other, but
increasingly they are less relevant from that perspective to us. I think on the
pet specialty perspective, as you mentioned, our largest direct competitor
remains private. They are opening stores at a healthy pace, they are investing in
marketing, and we think they are doing okay. This is an attractive sector, and
again it has been pretty stable in the dynamics.” – PetSmart 2013 Q2 Earnings
Call Transcript
x
“But another really important reason is exclusive for us. So, the PetSmart
shopper who buys a proprietary brand at very sticky behavior comes back to our
store and is very loyal to us. In terms of our assortment again emphasizing the
point around differentiation between our channel-exclusive offerings and our
proprietary brands if you look at the chart on the left hand side, we do not, I want
to emphasize, we do not overlap with more than 90% of our SKUs. So, 90%
of our SKUs do not overlap with mass and if you move to the right hand
side on the sales basis, 83% of our sales do not overlap with mass
retailers, so our assortment not only very broad is very differentiated from
mass retailers.” – Joe O’Leary, Head of Merchandising, PetSmart 2011 Investor
Day
xi
xii
“DAVID LENHARDT: It's the biggest portion of our food today and I'll talk about
us, 75% of the food that we sell is channel exclusive to us. Within that
category of food, organic and naturals is the biggest and it's the fastest growing.
And we see a lot of runway ahead of us there both again in dog as we continue
to bring in innovation and also in cat. We really start to focus on cat in a way that
we did in dog a couple of years ago.” – 2014 RBC Capital Market Conference
“Unknown Attendee: On your food category, you guys talked about 75% of
that being sort of exclusive to the pet specialty. Did I just hear you right that
you've said that a lot of that is available online, of that 75% that's exclusive to pet
specialty?
xiii
David K. Lenhardt - President and Chief Operating Officer: I think if you look
online, you will find in -- not all of our vendors are supplying the online players
directly but through diverters and just other distributors. I think if you look online
today, you'll see a fair amount of our assortment online absolutely.” – 2013 Bank
of America Merrill Lynch Conference
“When I went to PetSmart I would say more than 25% of all shoppers had a
dog on a leash with them. The grooming place was packed. There were 2
receptionists at the animal hospital. They were doing cat adoption. And they were
selling pets like lizards, snakes, etc. Overall, I would say PetSmart was by far the
most lively and interesting. It was absolutely full of animals. I was very
impressed with the service parts of PetSmart. They make them very visible.
I think customers who visit will keep in mind that they also have grooming
and a vet. It adds a lot to the pet centric atmosphere of the place. A lot of
both the dogs and employees are there for the services. Where I went the
grooming is all done with dogs on raised tables and with the entire
grooming section having glass around it instead of walls. So the animals
are on display. Anyway, it was totally different than any pet supply store
I've ever been to. The atmosphere in PetSmart was unique. But it was a
xiv
weekend and I didn't compare it to Petco. So that might be an overly optimistic
assessment of PetSmart's uniqueness.” – Geoff’s description of his visit to
PetSmart
“Overall, on average, PetSmart is 8% to 10% less than the other pet specialty
retailers as well as grocery and we are within 5% to 7% of max prices.” – Joe
O’Leary, head of merchandising, 2011 Investor Day
xv
“We, too, have heard some manufacturers talking about price increases on the
food side of the business. We think we are the price leaders for some, and
we're a price reference, at least, for several others.
xvi
We are ones who do our own original pricing off our own original algorithms and
what we understand about our own elasticities. That means in, I guess, more
simple terms that we price product off what it costs. So when stuff costs more we
do keep an eye on competitors and are vigilant in that regard, but the base case
here is that we price product based upon its cost and what we understand about
our own elasticities.
When we had price increases, I guess it was about two years ago, and now, the
behavior then was we priced our, we essentially pass through the prices and
after a short amount of time, the rest of the world, broadly speaking, passed
through as well, and competitive positions in that time were pretty much
maintained at slightly higher price points. I can't speculate what this time will
happen, but we'll price our product off the cost you pay for it then be vigilant as
we look at the competitive environment.” – Phil Francis, former CEO, 2005 Q3
Earnings Call Transcript
“What Tim said, yes. And remember, we're what I would call original pricers.
We don't go after name 'em minus some or somebody else plus some, we're one
who has our own price elasticity by subcategory, by competitor. The goal is to
optimize cash gross margin in the subcategory, and it just turns out that when
people do studies we're about 3 to 5 less expensive , or 10 to 17 -- 3 to 5 more
expensive than some and 10 to 17 less expensive than others. But as we do our
price optimization studies, if that told us the customer had moved and we should
move, those numbers would change. But we get there out of our own numbers,
not because we look at somebody else and use a calculator to do either a
fraction or a 1 point something or other calculation. We do original pricing. I'm not
sure there's many of us left.” – Phil Francis, former CEO, 2005 Q4 Earnings Call
Transcript
xvii
“Still, some retailers and manufacturers remain concerned about how they will
fit in an expanding distributor’s business model. Drasner says that SKU
rationalization among larger distributors can hurt not only small pet stores, but
also small manufacturers. “If you can’t do multi-million-dollar business with
these guys, they don’t want to allocate the space or sales resources to
your products. In some cases, million-dollar lines are being delisted,” he
says, conceding that the problem in those cases is often slower-moving SKUs
within the line. “Who would have ever thought that if you are doing a million
dollars worth of business with [a distributor], they just wouldn’t have the room for
you?”” – A Narrowing Pipeline, Mark Kalaygian, Pet Business Magazine, August
2013
xviii
“I view independents as a stepping-off point to launch you into PetCo and
PetSmart eventually, if that is where you want to go, and then you need to
support that with a huge marketing budget to grow even a new following,
because you are going to lose a good percentage of your sales from the
independents once you go into the big-box stores. Products like ours, you
will never see in grocery stores. If you put your product in a grocery stores,
independents will drop you like flies.” – From a managing partner at a
premium pet food manufacturer, Blueshift Research
xix
“Manufacturers always are likely to sell through mass channels. Manufacturers
start small, produce quality, and build a following with brand recognition—and
then they sell out. And the people that buy them out, like Procter & Gamble and
Mars, reduce quality. “ – from owner of a holistic-focused pet food manufacturing
company, Blueshift Research
xx
“We do not sell our high-end premium products at PetSmart. We do sell our
products indirectly to PetSmart on a third-party contract basis. But that is not the
core of our business. When it comes to Pet Smart and PetCo, we try to stay out
of the way of the Purinas and Proctor & Gambles. And we do just fine without
them, selling a couple of hundred million dollars a year through the pet specialty
channel. I’m talking about the independent, boutiques and small chains with 10
or so stores. Very few of the true premium-brand pet food manufacturers
attempt to sell in the mass-market channel. If a premium brand becomes
popular within the specialty/boutique pet store segment, it does not then
necessarily transition into PetSmart. What typically happens is that one of
the larger consumer product manufacturers acquires the premium pet food
brand and takes them into the chains.” – From a Vice president of a premium
pet food manufacturer, Blueshift Research
xxi
“Peter J. Keith - Piper Jaffray Companies, Research Division: Okay, fair
enough. And then the follow-on question to that is just with the proliferation of
some of these channel-exclusive brands, what is the risk that some of these
more popular brands might actually look to go more to the mass or grocery
channel just as they're looking to grow their business as any company would, if
you're just talking about maybe a Nutro or a Wellness. Does that come up in your
discussions with these companies as a potential risk?
xxii
David K. Lenhardt - Chief Executive Officer: Yes. Yes , it does come up quite
a bit. We talk about it all the time and we have very strong, terrific relationships
with the channel-exclusive vendors. We spend a lot of time working with them,
making sure they understand our strategy, what we need to accomplish. We
spend a lot of time understanding what they need to accomplish, what type of
pressure they may be and to do these type of things. And I can confidently tell
you at this point that every channel-exclusive vendor we work with today is very
committed to PetSmart and pet specialty and continue to grow because they see
that there's still a nice run rate of growth there. And I would tell you that the
innovational pipeline and the new products that they are working on to come in to
help us and the channel , I'm very confident that in the -- for the foreseeable
future, I don't think it's a big risk. And I would just add to that, we're very focused
on partnering with our customers to grow both of our businesses. And we've
been very successful at that in the past. The other thing I would mention is
there's been a -- there's only been one brand ever that has gone channel
exclusive to mass, which was IAMS and Procter & Gamble . And the other
vendors have looked and watched and seen the results of that. And when
you go mass, you get certain things. You get wide distribution, you
generally see margin compression, you also see your assortment
dramatically reduce. So I think there's a lesson out there that's instructed
to the vendors we work with. And again, and our focus is on continuing to grow
with them and grow both of our businesses. We've been successful at that and,
again, I share Matt's confidence that we continue to build a really good innovation
pipeline with them.” – PetSmart 2013 Investor Day
“PetSmart, with 12% of the pet food and supplies segment, is battling its
traditional rival, No. 2 Petco Animal Supplies (PETC), plus general big-box
retailers like Wal-Mart Stores (WMT) and Target (TGT).
xxiii
Hoping to stay ahead of the pack, PetSmart aims to boost its 9% share of
the highly lucrative pet-services segment, which includes grooming and
veterinarians, by adding animal hotels -- aimed primarily at dogs -- to many of its
850 stores. It also plans to increase its roster of stores by 100 annually over the
next five years.” – Fido’s at the Front Desk As PetSmart Adds ‘Hotels’, Tom
Sullivan, Wall Street Journal, 08 October 2006
“I would say comparing the Petsmart Grooming Services (and other services
i.e. training, doggy day care, etc) to a Professional Local Groomer (or other) is
like comparing Fantastic Sams or Great Clips to a local hair salon. Sure you are
going to get a better cut from the salon, but you will get a decent cut for
half the price at Great Clips; Great Clips is always full of people waiting for
a cheap hair cut which in Petsmart’s case is foot traffic. I’m not sure the
services are strictly about competing with local groomers and providing elite
service. I think they are more about providing a cost effective solution to their
consumers and a decent margin that gets people into their stores and has them
walking around shopping while they are waiting to pick up their dog from its
appointment. This may be why the vet clinic at PetSmart is outsourced. It may
have been easier to do a partnership with an established practice and get them
in the stores to drive traffic than to build a clinic from the ground up.” – A
comment from Corner of Berkshire and Fairfax
xxiv
“UNIDENTIFIED AUDIENCE MEMBER: I'm wondering if you could talk a little
bit about the service offering at the hotel business. Who are your primary
competitors? What are the typical price points? How many of your customers
tend to use those services? Those kinds of questions.
xxv
PHIL FRANCIS: Lots of questions on hotels. The venture capital rule of North
America kind of vaporized $ 300 million or $ 400 million in the late '90s and the
early 2000s. What's left is a business called Best Friends, which is East
Coast oriented, that has 40 or 50 hotels that are freestanding hotels and
they're alive and well. Other than that, there hasn't been really much that lasted
from the venture funding of those startups. Our competitors tend to be momand-pops, and oneseys and twoseys. When we bought our first hotel alone as
a laboratory, we bought it from people who had actually started and run
AlphaGraphics, and we bought them because they were trying to do smaller
mode services businesses and controlling quality of policies and procedures in
training. And hotel is a smaller mode services business that you need to have
control over. We thought that business would have been started with that in
mind. And indeed it was, and we learned some of that. So the competitors tend
to be oneseys and twoseys, rather than anybody that is big scale. It's a hard
business to do in quantity unless you're pretty good at services and quality
control in small remote kinds of places. It's all our staff, it's all our P& L, we don't
outsource. It's inside our stores. One reason it's effective is because of
extreme capital efficiency, as compared to a freestanding PetsHotel, which
would probably be in secondary real estate. We have about half the CapEx
of one of those, because it's inside a store and it's also in highly visible,
pretty easy to get to real estate. I like to understand why something works
and one reason our hotels work is extreme capital efficiency. And it's also
being bolted into an existing management team , and the bathrooms are
already there and there's already a store director to help the hotel manager
-- that sort of a thing. Price point wise, we would not be cheapest. We try to sell
dog food and cat litter cheapest; we don't try to do services cheapest. I can
describe to you a theoretical thing that probably doesn't actually exist, but if you
find 10 groomers or 10 trainers or 10 hotels, they all had no ties on price points,
that would be unlikely. But we tried to be seventh or eighth, with 10 being most
expensive. We try to be seventh or eighth, not first or second, but we try to have
the best experience, with the seventh highest price point. I think we sell products
based upon their price and the natural type of attributes that you sell services on
quality and the consistency of the experience. And that's how we would think
about pricing and generally is where we're price.” – 2007 Bank of America
Conference
“Francis says he can add a pet hotel to an existing location for less than
half the cost of building a similar standalone location. Plus, the hotel
shares the cost of the heating and air conditioning system, parking lot,
employee break area, armor car pickups, and other overhead. Overnight
stays start at $21 a night, $31 for a suite. Day care starts at $14 a day. After five
years the hotels can help boost a store's sales by 29% and double its profitability,
both because the hotels are a high-margin business and because customers
come more frequently and buy other things when they do. A typical PetSmart
store with a hotel earns $879,000 on sales of $7.1 million.” – The Battle to Be
Top Dog, Christopher Palmeri, Business Week, 05 August 2007
xxvi
xxvii
Based on PetSmart’s investor day presentation in 2011 and 2013
“Supermarkets had held sway by stocking their shelves with popular brands
such as Alpo, Kal Kan, and Purina, but beginning in the mid-1980s new premium
brands of pet food were introduced into the market. Premium brands such
as IAMS, Science Diet, and Nutro that offered higher levels of nutrition than the
supermarket brands became increasingly popular among pet owners, and
specialized pet products stores were the only retailers to carry such brands. The
changing dynamics of the pet products industry led to the decreasing strength of
the supermarkets and the growing prominence of retailers such as Petco.
Between the mid-1980s and the mid-1990s, the percentage of pet food sold
in supermarkets slipped from 95 percent to 50 percent, with specialized pet
products retailers, warehouse clubs, and mass merchandisers accounting
for the change. The conditions were prime for Petco's growth and expansion
into a national chain. In the reshaping of the pet products industry, the nearly 30xxviii
year-old regional retailer played a leading role.” – Petco’s history,
http://www.answers.com/topic/petco-animal-supplies-inc#ixzz33V7ONN10
“MATT FASSLER: Bob, thanks for those remarks. I'm going to start out by
thinking about pet demographics. You talked about your 5 millionth adoption.
Where do you see the pet household formation cycle today, and if you could give
us some context as to where it has been over the past several years? BOB
MORAN : First of all, we're in a healthy sector retail. As we said, the pet sector is
forecasted to grow 3% to 5% over the next three to five years. We look at the
current statistics that came out in 2011-2012 from APPA, which is our National
Pet Owner Survey. Approximately 62% of households in North America have
pets, which kind of equates to about 73 million households. Now, we go back in
time and look at that same data, the same survey for 2009-2010, the consistency
on that was that it was still 62%. There is the high correlation to pet acquisition,
pet ownership, to housing turnover, and pet adoptions kind of serve as a proxy
(inaudible) for us because the information is very fragmented, and there's really
no clearinghouse of total information. But about 25% of all pet acquisition is
counted through adoption. So we adopt about 1,100 dogs and cats per day in
our stores, and what we saw was a trend that stabilized in the first half of 2011
and started having some slight positive movements in Q3 and Q4 of 2011. And
those trends have continued for Q1 and Q2 of this year. It's not a trend yet, but
we're encouraged by the slight improvements, but we haven't seen any of the big
numbers that we have seen in some other publications. Again, as I said, the
information is somewhat fragmented. But I think we are well positioned for new
pet acquisitions. We are attracted to it because we get 2X for market share
when a pet is acquired in our house, especially with the new purchase of
supplies, the use of services. So we're very attractive -- we're very well
positioned for any type of macro movement in the pet acquisition side. But we're
still at 62%. MATT FASSLER : Does the share of adoptions versus purchases
move around when -- depending on whether we're in good times or bad? I would
think an adoption is cheaper than an outright purchase if somebody wants a pet.
BOB MORAN : I think the [fewer] acquisition of a pet through adoption is
definitely far cheaper. And it's obviously very attractive to a number of families,
especially have empathy in their core because they're doing something good not
only for the community, but they're also doing something good for the family.
Anytime you acquire a new pet, you get the puppy or moving towards and adult
age, there's a need for supplies inside the household, so we find that as to be a
very attractive commercial event for us, and we think we can serve a trusted
advisor in that world.” – 2012 Earnings Call Transcript
xxix
“One is things that we can control and one of the things that we can control is
pet acquisition. We adopt over 1,000 dogs and cats everyday in our stores, and
xxx
we believe that we can influence that to a higher rate, and we believe when we
do get an adoption it affects within our stores. We get the benefit of the
additional supplies and consumable purchases that take place. So we are
working out with our major consumable vendors, programs where they will
sponsor everyday adoption events within our stores, cutting cost through moving
from us, feeding the pets to they feeding the pets, but also providing incremental
marketing spend and also making contributions to PetSmart Charities. We are
working with another vendor in particular that will sponsor the quarterly
adoption events. In this weekend coming up, we expect to adopt over
20,000 pets this weekend and how a vendor looks at that and why he takes
back value, they believe that 20,000 pets being adopted staying within their
food is the equivalent of about $ 100 million life time value for their
company. So that's why they invest additional marketing dollars for that. And
then we're working with another vendor in particular that they work with shelters
across the United States, and they have been very successful in creating
adoptions of in the millions and we are working with them with exclusive bounce
back coupons. When an adoption does happen in a shelter, the pet parent
customer -- actually are pet owners; they don't become pet parents until
they bond -- will come into PetSmart to make the purchase for their food.
And then last but not least, we are working with another vendor. We have a
program within PetSmart Charities called Rescue Wagon, where we take excess
of dog and cats from one area of country to another for adoptions, and not only
will there be a sponsorship, but there will be a lot of marketing blending both
PetSmart and PetSmart Charities from a community content point of view. So,
from a -- we got a -- we've experimented with that this year. We got a killer
program for next year that we think we can influence the retention adding new
customers.” – Bob Moran, former CEO, Goldman Sachs 2009 Conference
“In a somewhat ominous sign for smaller pet shops, the GfK MRI reports also
show that Millennials are more likely to shop at big-box stores (Petco,
PetSmart) and online—most likely, in search of better deals and
convenience. Millennials are less likely to shop at small pet-specialty
stores, a potential threat to independent retailers in the future.” – Closing to
Generation Gap, Maria Lange, Pet Business Magazine, May 2014
xxxi
Durability
Will Online Competition Kill PetSmart?
Visits to pet retailers' websites (millions), source: comscore
petsmart.com
petco.com
wag.com
petflow.com
4Q'12
2Q'13
4Q'13
30
25
20
15
10
5
0
1Q'12
2Q'12
3Q'12
1Q'13
3Q'13
1Q'14
Website traffic to PetFlow.com grew astronomically in recent quarters
-
-
The pet market has favorable future
o Expects to grow at or slightly above GDP growth rate
PetSmart has sustainable moat in brick-and-mortar business
The biggest change that retailers face is from online competition
A subscription model would be attractive to customers
o People know how long they’ll run out of food
o Attract customers for convenience
But it’s hard to make money by selling foods online
o Shipping cost of a 30-pound bag is about $20.5
 PetSmart.com charges $20.5 for a 30-pound bag
 Using intershipper.com to find the cheapest service
• Shipping 30-pound bag from New York to Philadelphia
o FedEx Ground: $17.05
• Shipping 30-pound bag from Texas to Texas
o FedEx Ground: $17.05
• Shipping 30-pound bag from Texas to California
o FedEx Ground: $37.41
 In 1999, it costs about $15 to ship a bag of dog food i
o Gross margin is 20-30%
 Based on food cost alone, specialty stores has 25% gross margin
• According to Pet Industry Distributors Association in 2013
o Distributor sales: $3.3 million
o Retail sales: $4.45 million
o => 25.8% gross margin
 According to IBIS World March 2014
• Purchase costs is 58.4% of the sales
o => 41.6% gross margin, excluding warehousing, rent
and utilities cost
o Pet supplies has much higher margin than pet food
o => It’s more likely
 50% - 60% gross margin for pet supplies
 Lower than 30% gross margin for pet food
 PetSmart merchandise gross margin is about 30%
• Over 1/3 of merchandise sales are pet supplies
o About 2 times pet food’s gross margin
 UBS analysts estimate PetSmart has 20% gross margin on food
 => gross margin for online competitors is about 25-30%
• Excluding order processing and fulfillment cost
o Online competitors can only make positive gross margin by selling ultrapremium food
 Selling Blue Buffalo is not enough
• 30 pounds
• $56.99
• Free shipping
• 30% gross margin => $17.1 gross profit
o Not enough to pay for
 Shipping cost
 Order processing cost
 Selling $3 per pound food may work
• Orijen Regional Red Recipe Dry Dog Food
o 28.6 pounds
o $92.99
o Free shipping
o 30% margin => $27.9
o => can make profit
o => compete with independents on these foods
-
o PetFlow’s plan is to make money from selling food subscription ii iii
 1.5% monthly attrition rate
 60% of sales coming from a subscription basis iv
o But it’s hard to make money
 Food cost and shipping cost are two big variable cost
 => doesn’t scale up well
o Pets.com had negative gross profit
 9 months ended 30 September 2000
• Sales: $25.8 million
• Gross Profit: - $6.9 million
E-commerce makes more sense with products with 3 characteristics v
o High ticket
o High margin
o Low weight
o Flea and tick is
 High ticket
 High margin
o => 1-800-Pedsmed is the leader
o Online sales is less than 15% of the flea and tick market
 PetMeds’s online sales in 2013 was $184 million
 Flea and tick market is $1.3 billion
 PedMeds sell other pet medications other than just flea and tick
 2.6 million customers purchased from PetMeds in the last 2 years
• 82 million households own pets
• => less than 3.2% penetration
o Despite about $27 million advertising
o PetMeds has 33% gross margin
 Average purchase is $75
 Foods may have 10% lower gross margin
• => $17.25 gross profit if they sell foods
 Foods cost a lot more to ship
• At least $10 more
 => less than $7.25 gross profit per order if PetMeds sell food
instead of medications
• => less than 10% gross margin
 Blue Buffalo adult pet food
• 30-pound
-
• PetMeds: $69.99
o Free shipping
• PetFlow: $53.99
o Free shipping
• If PetMeds has 33% gross margin on this item
o (unlikely)
o => cost of sales is $46.9
o => PetFlow can make $7.1 gross profit
 => about 13% gross margin
• If PetMeds has 23% gross profit on this item
o => PetFlow wouldn’t make any gross profit
 PetMeds spends about
• 9% of sales in G&A
• 12% of sales in advertising
o Assuming PetFlow can make $5 gross profit per $50 bag food
 A person spend less than $500 per year on pet
• Average annual spend on is
o Dog food: $239
o Cat food: $203
 => PetFlow can make less than $50 per customer per year
 PetMeds has over $20 million G&A
 => PetFlow needs 0.4 million customers to cover G&A expenses
• => $200 million revenue
 PetFlow sales was
• 2011: $13 million
• 2012: $30 million
• 2013: $39 million
 => need 5 years of 40% annual growth to pass $200 million sales
• It took PetMeds 6 years
o 2003: $55 million sales
o 2009: $219 million sales
o PetMeds made money every single year during the
period
o PetMeds offers customers
 Lower price than vets
 Convenience
Damage from online competition is limited
-
o For supermarket & mass retailers
 It’s hard to make money by selling cheap food
 But PetFlow do carries low-end brands
• Beneful
o 31.1 pounds
o $41.99
• Iams
o ProActive Health Adult MiniChunks Dry Dog Food
 60 pounds
 $77.98
• Pedigree
o 17 pounds
o $22.99
• Purina One
o SmartBlend Chicken and Rice Dry Dog Food
o 31.1 pounds
o $45.99
• => can attract people who buy food at supermarket & mass
retailers
o They only buy foods or supplies at these place
o They want convenience
 Don’t make a special trip to specialty stores
o For pet specialty stores
 Specialty stores that sell only expensive food would face the most
problems
• PetFlow sells Orijen dog food
 PetSmart has services that keep customers loyal
 Most valuable customers enjoy in-store experience vi
• Customers are not excited about buying online vii
o Pet food is not a planned purchase
o People don’t want leaving pet foods outside
• PetSmart’s online customers also buy in-store viii
o Online order is more weighted to hard goods
o They shop in-store more than average customers
• Geoff’s in-store experience was great
If share shifts to online competitors
o PetSmart can offset by gaining share from
-
-
-
-
 Independent competitors
• About 13-15% market share
 Supermarket and the mass channels
• Some share will shift to specialty channel overtime
PetSmart is testing order online, pick up in-store
o Order online, ship from store is an easy extension
o Currently customers can check in-store availability of products
 PetSmart.com is the most frequently visited pet website
 10% of PetSmart store sales were directed by PetSmart.com ix
o If there’s a trend to online, PetSmart can have better economics than
competitors
o Problems:
 Losing traffic to stores => reduce hard goods sales
 Retailers may not focus on customer’s convenience
• They want customers to go to stores
Subscription model makes sense on the customer side
o Not make sense on the supplier side
 Pet food is low margin, high weight, low value to weight
 Hard goods has higher margin but no one subscribes for hard
goods
Amazon Pantry make sense on the supplier side
o Customers can order 45-pound box for a flat fee
 The basket can be similar to a basket at Wal-Mart
 People will try to fill the basket
• Amazon can lose money on some items
• But overall gross margin can be similar to that at Wal-Mart
 Gross profit can be good enough to cover shipping fee
o But it might not attract PetSmart’s customers
 Selections would be limited
• Because Amazon has to build selections in a lot of things
 Ordering a basket with Amazon is just like going to Wal-Mart to
shop
• May not attract customers who give a special trip to
PetSmart
PetSmart can find new ways to monetize traffic to stores
o Core strength:
 Store traffic
-
 Brand images
 Scale
o They can reinvent themselves
 Or can replicate new ideas to their stores
o Spending mix for pet might change
 Just like human
 PetSmart is in the best position to take advantage of favorable
trends
A trend to fresh foods can be a problem
o Grocery stores has better logistics to sell fresh foods
“Pets.com, San Francisco, which is partially owned by Amazon.com Inc.,
already ships big bags of food for just $4.95 shipping and handling. Chief
Executive Julie Wainwright insists that the company does so profitably, although
competitors say it costs three times that price to ship such an item via most
delivery services” – Big Pet-Supply Retailers Try to Tame the Competition,
Frederic Biddle, Wall Street Journal, 20 August 1999
i
ii
“Prices, Zhardanovsky said, compare with what customers would be paying at a local
store. They have a $4.95 fee for purchases under $59 dollars, but he said their average
consumer spends about $80 dollars.
“We make less on each shipment, but we can count on many shipments to that
customer over the lifetime of their pet, so it makes sense for us to offer it that
way,” he said.” – The Power of Paws… Online, Christina Scotti, Fox Business, 25 April
2012
“Alex Zhardanovsky: The metrics do back out. The difference between us and
Pets.com is a big one. If you look at any of their advertising, most of their ads
were centered around a Frisbee, a toy, the tennis ball, the dog bowl or a bed,
basically non-consumables that the customers really did not need. They were
nice to have, but if I bought a dog bed yesterday, I really don’t need you to give
me discounts on another dog bed for the next 10 years.
iii
We started the business in a completely different way. We are selling you
products that you have to have. So, because of the fundamental difference
in the business model, our customers HAVE to have the product that we
are selling them. So what we see is about 50% of our new customers sign
up for auto ship on their very first purchase. The other 50% make a one-time
purchase and then they usually come back to the site and make subsequent
purchases on an as-needed basis. Again, these are products that they HAVE to
have.” – Interview with Alex Zhardanovsky from PetFlow,
Meetinginnovators.com, 23 February 2013,
iv
“Customers who sign up to receive regular deliveries of pet food can determine
how much they get and how often it comes through PetFlow’s Web site. They
can also suspend or change delivery locations when they move or go on
vacation. So far, Mr. Zhardanovsky said, only about 1.5 percent of his
subscription customers drop the service each month — and many do so
only because the pet has died.
In its first month, July 2010, the company shipped about 60 orders; by January of
this year, that number had leapt to 27,000. In 2011, PetFlow exceeded $13
million in revenue — with 60 percent of its sales coming on a subscription
basis — and it projects revenue will exceed $30 million this year. “I’ve come to
appreciate,” Mr. Zhardanovsky said, “that subscription models are, in so many
ways, the holy grail of business.”” – Among Online Entrepreneurs, Subscriptions
Are All Rage, Darren Hahl, 07 March 2012
“We believe, from an online penetration perspective, that the market is between
2% to 3% penetration. And so if you think -- and by the way, against that market
growth of 12% to 14%, we've been outperforming that from an e-commerce sales
perspective. But from that context, on a relative basis, this is not a particularly big
penetrated retail sector. And I think when you think about some of the dynamics
going back to categories in our store that are more or less prone to being
penetrated, I think there are 3 big dynamics you need that drive increased
penetration in the retail sector. One is high ticket, one is high margin and
one is low weight. And when you think about our store, there's actually not
much in our store that qualifies for that. Food, you've clearly got a big weight
issue. But when you think about the hard good side of our business, the
average ticket for our hard goods is $ 12. So that's not a particularly high
ticket. One category that has done very well , historically , from a
penetration perspective that I think falls into this bucket is flea and tick. So
flea and tick is high ticket, it's high margin, it's low weight. And I don't think
it's any coincidence that the #1 player in the online space is PetMeds, the
large majority of their sales are flea and tick. Now, having said that, we got
into the flea and tick world 3 years ago. And you can look at how PetMeds has
done since then. But I think the customer continues to show us that they care
about buying in a retail environment and they like the shopping experience. So
we think it's very important, omni-channel. E-commerce is a piece of that. We're
v
focused on improving our website and we've made a number of changes over the
past year. We're not done. We're not where we need to be. You're going to see
us continue to do that. We've got a partnership with GSI that we've just renewed
for another 3 years. GSI does our fulfillment and our website experience. We like
the capabilities that they bring to bear on that front in particular because 2 years
ago, they were acquired by eBay. We've had a number of conversations with
eBay and we think eBay brings a lot of capabilities that we can leverage into our
omni-channel strategy going forward. So more to come and e-commerce is an
element of it, but it's part of a broader strategy.” – David Lenhardt, COO, UBS
2013 Conference
“MICHAEL LASSER: Then how do you think about the interconnection between
your real estate strategy and ubiquitous distribution of online? So I think we are
starting to hear more from retailers across the board that if e-commerce
penetration increases, maybe that will refocus some of the store expansion effort.
What is your philosophy with respect to that topic?
vi
DAVE LENHARDT: We think it is absolutely a combination of both. So when you
look at our offerings, we have got a number of our offerings that you can only get
in our stores. Let me start with services. So services is 11% of our business,
grooming, PetsHotels , and training. You need a store to deliver that. We
think that that is a big piece of who we are and why our customers come to
visit us. We also know that it is important to have the convenience of our stores
to our customers. I think you have seen us migrate towards smaller store formats
from the days that we were 27,000 square feet. We also increasingly view our
stores as an opportunity to help with our fulfillment of online. So as we
think about the capability of order online, pick up in-store, that very much
allows us to leverage our footprint. And as we build out the order online
pick up in-store capability, that then gives us a foundation to move to order
online, ship from store, all of which help us start to optimize the economics
of e-commerce but, again, also offer a convenience for our customers. Our
customers have told us the number 2 feature that they have asked for is
order online, pick up in-store.
So we think there is definitely a place for both online and e-commerce. But we
also think just as importantly, our stores play a key role. And the last piece would
be our stores are a great shopping experience for our customers. So customers
come in with their pets, without their pets, but it is an enjoyable experience.
I think often some shopping experiences can be considered drudgery.
Shopping for diapers is an example. There is not much fun shopping for
diapers. Customers have fun in our stores, and they have told us that they
enjoy that experience. They interact with our associates who are very
passionate about pets. They interact with other pet parents. And that
community that goes on in our stores, we believe, is a key differentiator for
us. And our stores are a meeting place for our customers, and we don't
foresee that changing in the future.” – UBS 2014 Conference
“To give you a little bit more color, most of what our customers buy online are
hard goods versus food. We are selling food, but that's nowhere near the majority
of the product we sell. And as we -- we've done a lot of study and particularly
talking to our customers in this marketplace. And what we've seen is, from a food
perspective, customers are not viewing that as a very attractive channel for them
to purchase food today. And as we talked to our customers and done a lot of
research with them, 2 key insights have come out. One is food is not as
planned a purchase as you might think it is. So when we talk to our
customers, what they tell us is they don't go into the bag of dog food, start to
scoop out food and say, "Well, I've got about 8 scoops left. That's 2 days, so I
better order today." They just don't think that way. They typically realize they're
out of food when they go to the cupboard and they go, "Uh, oh. I'm out. I now
need to go get a bag of dog food. So without that planned purchase, you can see
it's much more about in the moment they need the product. That's the first big
insight. The second big insight is when you ask customers who have both had
food delivered online but who have thought about it, both of them have a very
similar reaction, which is they're not that excited about the idea. And in
particular, most of the time, they're not going to be home when the food
gets delivered, so that bag of dog food is sitting outside. So they're
concerned about the climate. They are concerned about critters eating it,
and they just don't feel good about that experience. And I think a good
analogy would be human food. We haven't seen a very large penetration of
human food online to date, and I think customers think about it in very much the
same way. So that's why we see not as much penetration of food and, again, the
mix going back to our business, we see much more hard goods than the food.” –
David Lennhardt, CEO, PetSmart 2013 Investor Day
vii
“UNIDENTIFIED AUDIENCE MEMBER: Then can you tell us, what's the
difference in the transaction when it comes entirely online versus in the store?
For example, how is the basket different? Is it just big bulky items that people are
getting that way? How is the margin different? How is the attachment rate? So
when you're in the store maybe you pick a toy; I don't know if online you have a
way to make or encourage people to do that.
viii
DAVID LENHARDT: The mix right now online for us is a little bit more
weighted to hard goods. We do know that our online customers are more
valuable customers overall. So those customers also buy in-store. If you
look at collectively what they buy, they are a more attractive customer than
our average PetSmart customer. So it is absolutely a customer that we want to
remain relevant with.” – Bank of America 2014 conference
“Finally, I'd like to talk you about how we're building new capabilities to convert
these pet parents into loyal customers by simplifying their path to purchase. We
believe that technology can do just that and is often the intent of our omnichannel strategy. This strategy is based on a significant amount of consumer
research and customer insight and we have 2 focused areas: The first is
profitably growing our online sales. The second is profitably growing store sales
by converting website visitors into store customers. The first ingredient for
success is having a highly-visited website and petsmart.com is the #1
visited website in the pet retail industry. So we're building often already
strong foundation. About 10% of our store sales or about $ 700 million per
year are driven by shopping trips to start on petsmart.com. This is the
focus of our e-influence strategy and it provides a great opportunity for us
to monetize our traffic as a multi-channel retailer. To grow this, we recently
launched the #1 requested feature that customers have of our website
experience, in-store availability. Customers want to know in realtime that the
product that they're looking at on our website is available and in stock in their
local store. We launched this feature for consumables this year and will expand it
to other categories in '14. Our e-commerce business is growing faster than
the online industry, which we believe is growing at about 12% to 14% per
year, so we continue to profitably grow market share by expanding our
offerings and increasing our capabilities.” – John Alpaugh, PetSmart Chief
Marketing Officer, 2013 Investor Day
ix
Quality
PetSmart: Not Just a Retailer
Services as % of sales
SG&A/Sales
EBIT Margin
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Services help improve PetSmart’s profit margin
-
-
Stable business
o Food is stable, recession-proof
o Hard goods is discretionary
 Depends on traffic
 % of sales declined
o Service like grooming is stable
o Hotel depends on travel
PetSmart make high return on capital thanks to high volume and scale
o Retailers tend to have similar margin
 Key is to generate high enough volume to cover operating
expenses
o PetSmart is the price leader
 Follows everyday low price strategy
 PetSmart price is
• 5-7% above mass retailers i
• 8-10% below specialty competitors and groceries
 PetSmart is the original pricer ii iii
• Set price reference for others
o Scale allows give PetSmart higher margin than independents
-
 According to IBIS World March 2014, pet specialty’s average
profit margin is 3.6%
 PetSmart’s 2013 EBIT margin is 10%
o Higher margin and higher volume => higher return
PetSmart’s strategy is different from Petco
 PetSmart has higher sales per square foot
• 2005:
o PetSmart: $206
o Petco: $187
• 2004:
o PetSmart: $205
o Petco: $190
• 2003:
o PetSmart: $197
o Petco: $190
• 2002:
o PetSmart: $189
o Petco: $188
• 2001:
o PetSmart: $177
o Petco: $180
 PetSmart has lower rent
• Since 2001, rent per square foot ranged between $11 and $12
• Petco’s rent per square foot increased steadily
o 1995: $15.20
o 2005: $17.43
• Rent expense/sales
o PetSmart: decreased steadily
 2001:7.8%
 2013: 4.8%
o Petco: stable about 9%
 Gross profit per square foot are quite close
• 2005:
o PetSmart: $65.17
o Petco: $62.48
• 2004:
o PetSmart: $64.34
o Petco: $66.28
• 2003:
o PetSmart: $61.76
o Petco: $64.32
• 2002:
o PetSmart: $56.52
o Petco: $59.19
• 2001:
o PetSmart: $52.63
o Petco: $54.81
 Gross profit per square foot is quite similar because
• PetSmart’s price is 8-10% lower than Petco
• Petco has higher gross margin
o About 2% higher
• Petco has a different sales mix
• In 2005:
o 30% of Petco’s sales was from dog and cat food
o 67.5% of Petco’s sales was from pet supplies and small
animals
o 53% of PetSmart’s sales was from pet supplies and small
animals
• From 1995 to 2005, Petco’s gross margin increased steadily
o 1995: 23.8%
o 2005: 33.4%
• The improvement in gross margin was thanks to Petco's focus on
selling more pet supplies iv
 PetSmart has lower inventory turns than Petco
 Cost of Goods Sold/Average Inventories
• PetSmart: 6
• Petco: 7.5
• Perhaps pet supplies have higher turnover than pet foods
 It seems
• PetSmart focuses more on volume and price
o Stores are not conveniently located v
o Each store trading area is a 5-mile radius
• Petco focuses on customers’ convenience
o Petco’s stores are conveniently located vi vii
-
-
o The two companies improve margins in different ways
 PetSmart focuses on services
• Has lower gross margin
• But two times EBIT margin of merchandise sales viii
 Petco focuses on pet supplies and small animals
• Has higher gross margin
 In the long run, focusing on services will be better off
• Higher margin expansion potential
• Improve pet-centric atmosphere
PetSmart has very good return on a levered basis
o PetSmart has been able to improve EBIT margin to 10%
 Reduce SG&A/Sales overtime
• 2004: 23.2%
• 2013: 20.6%
 Growth in services reduces SG&A/Sales
• Services as % of sales
o 2004: 7.2%
o 2013: 11%
o Sales/NTA is about 4.39
 From 1996 to 2013
• Min: 3.35
• Max: 5.41
• Median: 4.39
• Mean: 4.37
• STDEV: 0.59
• CV: 14% (very stable)
o => return on invested capital is about 43.9%
On unlevered basis, PetSmart has lower quality than AutoZone but better
than Home Depot
o PetSmart has better inventory turns
 PetSmart: 6
 Home Depot: 4.4
 AutoZone: 1.6
 Better than Home Depot
 Much better than AutoZone
 Both these companies need to maintain availability of a wide
selection
o But PetSmart has lower asset turns
 Sales/Average (NTA + 8*Rent Expenses)
• PetSmart: 1.47
o But asset turns improved consistently
 2004: 1.5
 2013: 1.8
o PetSmart improved sales per square foot while
controlling rent per square foot
 Sales per square foot
• 2004: $205
• 2013: $246
 Rent per square foot
• 2004: $12.06
• 2013: $11.77
• Home Depot: 2.09
• AutoZone: 2.02
 Reasons
• Inventories/NTA is lower at PetSmart
o PetSmart: 19%
o Home Depot: 30%
o AutoZone: over 60%
o => reduce the benefit of high inventory turns
• PetSmart sells lower value products
o Sales per square foot is lower
 PetSmart: $246 (2013)
 Home Depot: $$334 (2013)
 AutoZone: $265 (2013)
o Although PetSmart has higher traffic per square foot
 Average ticket at Home Depot: $56.78
• => 5.9 visits per square foot
 Average ticket at PetSmart is less than $40
• => higher than 6 visits per square foot
o => PetSmart has lower Sales/Capitalized PPE
 PetSmart has lower Payables/inventories
• PetSmart: 0.34
• Home Depot: 0.5
• AutoZone: 1.2 (negative working capital)
-
• => PetSmart has lower power over suppliers
o Pet food companies are big
 To be fair, Home Depot and AutoZone’s land is reported at cost
• Asset turns would be lower if using assets’ market price
o AutoZone has great margin
 20% EBITR margin
 => over 44% unlevered return on capital
o PetSmart has better EBITR margin than Home Depot
 From 2004 to 2013
 PetSmart
• Min: 12%
• Max: 15%
• Median: 13%
• Mean: 13%
• STDEV: 1%
• CV: 0.06 (very stable)
• Currently 15%
o Improving
 Home Depot
• Min: 7%
• Max: 13%
• Median: 11%
• Mean: 11%
• STDEV: 2%
• CV: 0.17 (pretty stable)
• But more volatile than PetSmart
o Has some exposure to the housing market
o => PetSmart has slightly better quality than Home Depot
 PetSmart has lower asset turns
 PetSmart has higher margin
• And is improving margin
 => similar unlevered return on capital
 PetSmart’s business is more stable
Life time value per customer is high
o Customer habit is attractive
 Purchase frequency is not high enough for a budget item
-
• Fewer than 20 times a year
 Price is not high enough to shop around
• Less than $40 sales per transaction
o Vet or service customers are extremely loyal
 Pet-centric atmosphere help retain customers
o Spending over lifetime of each pet is stable
 PetSmart top customers are loyal
• Buy channel-exclusive products
• Use services
 PetSmart has chance to increase spend per customer
• Annual gross profit per customer increases ix
o 2.1 times with grooming
o 4.6 times with grooming and boarding
8 dimensions of qualities
o Relative size
 PetSmart dominates the specialty market
• According to IBIS World March 2014
o Pet specialty market was $16.5 billion
 PetSmart: 40.3% market share
o Petco: 19.5% market share
• There are 13,156 players
o 59.1% of players are nonemployers
 Stores without paid employees
o 83% of players have fewer than 5 employees
o Only 7.8% of total operators have more than 20
employees
 Relative size with suppliers is good
• Two largest vendors accounts for 19% of sales
• Mars and Nestle sell more pet foods to the mass channel
o Focus
 PetSmart focused on pet products and services
• Wal-Mart or Target are general retailers
o May not build a pet-focus relationship with customers
o They get customers mainly by convenience
• PetSmart brand reach new pet owners easier
o Can focus on growing the customers
 Offer customized deals, etc.
 Change customer behaviors
• Buy premium foods
• Use services
o Can get new customers better
 Customer can think about PetSmart when
think about pet stuffs
 Provide in-store adoption program
• Found homes for approximately 440,000
pets in 2013
• Found homes for over 5 million pets
since 1994
 Products and services can have different models
• Food: is very stable
o In bad time, customers don’t trade down
o They see pets as a family member x
• Hard goods:
o Can have inventory risks
o Depends on store traffic
 Cross-sell
o More discretionary purchases
 Hard goods sales as % of sales declined due
to the crisis
• 2007: 38%
• 2013: 32.8%
• Grooming: labor intensive
• Hotel: capital intensive
o Depends on occupancy rate
• All products and services help build a pet-centric store
experience
o All depends on volume
o Customer engagement
 Quite high
 25% of customers go to stores with their dogs
 Top customers go to stores about 17.8 times a year
• Once every three weeks
o Cross-selling
 PetSmart has great opportunities
• Can easily sell more once customers are in-store
• Did a great job bringing human brands to hard goods
o Over 25% of merchandise sales are proprietary
o Mostly in hard goods
 No big suppliers in hard goods
o PetSmart license exclusive human brands like
 Martha Steward
 Bret Michael
 GNC
 Disney
 Etc.
o Example of some products
 Bret Michael top dog grooming package has a
Michael bandana and cologne xi
 Martha Steward Out of Sea assortments xii
• Featuring tropical inspiration sea life
creatures
• Pet Perks program help increase revenue per customer
o A loyalty program
o In 2008, 75% of sales was with Pet Perks customers
o PetSmart has a database of 38 million customers
 17 million are Pet Perks members
o PetSmart can trace 90% of sales to these individuals
o About 80% of communications are personalized with
Pet Perks
 Deal alerts
 Promotion with a particular breed
• Or a type of products xiii
 Pet Perks change customer behavior xiv
• Trade up on foods
• Use more services
• => more loyal
 PetSmart can do a lot better
• In 2011, top 13% customers account for 51% of sales
o Smart with Heart customers
 13% of customers
 51% of sales
o
o
o
o
 Average 17.8 transactions per year
 Average annual spend: $657
 => Average spend per transaction: $37
o Smart customers
 48% of customers
 41% of sales
 Average 4.1 transactions per year
 Average annual spend: 150
 => Average spend per transaction: $36.6
o Mart customers
 39% of customers
 8% of sales
 Average 1 transaction per year
 Average annual spend: $34
• Most valuable customers are customers who xv
o Buy channel-exclusive foods
o Use services
o New pet parents
Retention
 Smart with Heart customers are very loyal
 Mart customers are one-time customers
Words of mouth
 N/A
Reinvestment rate
 Spend 1.5% - 2% of sales on advertising annually
• Total over $1.4 billion since 1994
 Spent about $300 million in IT since 2005
• Building features like
o Check in-store availability online
o Order online, pick up in-store
 Spent almost $170 million in 199 hotels
Stock’s popularity
 Short-interest: 17.8% of float
 98.61 million floating shares
 Analyst coverage: 25
“Overall, on average, PetSmart is 8% to 10% less than the other pet specialty
retailers as well as grocery and we are within 5% to 7% of max prices.” – Joe
O’Leary, head of merchandising, 2011 Investor Day
i
“We, too, have heard some manufacturers talking about price increases on the
food side of the business. We think we are the price leaders for some, and
we're a price reference, at least, for several others.
ii
We are ones who do our own original pricing off our own original algorithms and
what we understand about our own elasticities. That means in, I guess, more
simple terms that we price product off what it costs. So when stuff costs more we
do keep an eye on competitors and are vigilant in that regard, but the base case
here is that we price product based upon its cost and what we understand about
our own elasticities.
When we had price increases, I guess it was about two years ago, and now, the
behavior then was we priced our, we essentially pass through the prices and
after a short amount of time, the rest of the world, broadly speaking, passed
through as well, and competitive positions in that time were pretty much
maintained at slightly higher price points. I can't speculate what this time will
happen, but we'll price our product off the cost you pay for it then be vigilant as
we look at the competitive environment.” – Phil Francis, former CEO, 2005 Q3
Earnings Call Transcript
“What Tim said, yes. And remember, we're what I would call original pricers. We
don't go after name 'em minus some or somebody else plus some, we're one
who has our own price elasticity by subcategory, by competitor. The goal is to
optimize cash gross margin in the subcategory, and it just turns out that when
people do studies we're about 3 to 5 less expensive , or 10 to 17 -- 3 to 5 more
expensive than some and 10 to 17 less expensive than others. But as we do our
price optimization studies, if that told us the customer had moved and we should
move, those numbers would change. But we get there out of our own numbers,
not because we look at somebody else and use a calculator to do either a
fraction or a 1 point something or other calculation. We do original pricing. I'm not
sure there's many of us left.” – Phil Francis, former CEO, 2005 Q4 Earnings Call
Transcript
iii
“Gross profit as a percentage of net sales increased to 33.2% for fiscal 2003
from 31.2% in the prior year period. The increase was driven partly by the
continuing change in mix from lower-margin premium pet food sales to
higher-margin categories such as pet accessories, supplies and services,
iv
which accounted for an increase in gross profit of 0.9% of net sales.” –
Petco 2003 10K
“PetSmart's bricks-and-mortar presence also attracts online shoppers who have
never set foot in a PetSmart retail outlet-primarily because the store is not
conveniently located. As McGovern explains, "We have high brand awareness
but limited store trading areas." In fact, he estimates that less than 10%
of PetSmart's online customers are also PetSmart store customers.
v
McGovern reckons that each store's local trading area is a 5-mile radius, "so
even in a city like Los Angeles, where we have eight stores, 95% of the
geographic area does not fall into a trading area." Nonetheless, in markets
where the company has stores, its television ads cover the entire region. So
customers who want to shop from PetSmart but live out of range can just log
onto the Website. As for cannibalizing the print customers of its R.C. Steele
catalog (which has its own Website), "we're not concerned about crossover at
all."” – Vying to Be Top Dog, Leslie Goff, Catalog Age, February 2000
“Despite competition from industry giant PetsMart in all its markets,
pricing isn't a major issue for Petco, Devine said, since it has positioned
itself so that price isn't a large factor in attracting customers.
vi
Petco stores generally are located in higher-end locations, Devine
explained, in areas where women tend to shop, and they sell middle-to
upper-end merchandise.” – Petco Buys P.T. Moran Pet Superstores, Discount
Store News, 01 April 1996
vii
“Petco's current prototypical format is in the 15,000-sq.-ft. to 17,000-sq.-ft.
range with an assortment that includes approximately 11,000 active skus. The
assortment will vary by the size and location of the store.
"This format gives us room to put our full assortment in and gives us room to add
new elements as they come on line, but it's not so large that it's intimidating to
the customer, and it doesn't have a warehousey kind of feel," Asselin said. "One
of our strengths is that we've been able to locate our stores conveniently in
neighborhoods, shopping centers next to Blockbuster Video, next to
Barnes & Noble, next to a grocery store where people are shopping
frequently as opposed to a destination where they have to drive a long
way."
Petco's mantra is customer convenience, and that translates directly into how the
individual stores (within Petco's diverse store base) are merchandised.
"Convenience is the most important factor for us. We want to be where people
are shopping so we can catch them when they're out making a frequent shopping
trip," Asselin said.” – The Clever Copycat, Robert Scally, Discount Store News,
08 December 1997
“MATTHEW FASSLER: I just have a couple of follow-ups. First of all from
some e-mails I am getting from investors. People kind of wanted to be reminded
about the margin structure of your services business versus your product
business in terms of the gross margin and SG& A mix. And particularly to get a
sense of whether that has changed at all, given changes in the mix of services?
In other words, have services always been a lower gross margin, lower SG& A,
category for you, and has that changed now that the mix has moved around?
viii
TIM KULLMAN [former CFO]: Let me just do a refresher here for us on (multiple
speakers) impact both gross margin and expenses. The services business is
dilutive to gross margin. And as you recall, labor is the cost of goods for
our services business. But it is two times more profitable than the core
store from the operating margin line. That has not changed. The services
sales gross -- as you know, we're now at 8.9% of sales -- had a little bit more
impact on margin in this year's first quarter because of the high penetration.” –
PetSmart 2006 Q1 Earnings Call Transcript
ix
PetSmart 2011 Investor Day Presentation
“VIVIAN MA: So is it fair to say that you haven't noticed customers switching
from a premium food to lower end grocery food as they felt pinched by gas
prices, et cetera?
x
PHIL FRANCIS [former CEO]: Vivian, no. And remember this, these are
family members, not livestock that we are serving, and remember, too,
when you switch a food from high to low or low to high , there is a big risk
of upset stomach and all that that implies in terms of a -- I delicately call the
quality of the relationship in the home. So there is a barrier to switching
food related to performance of the digestive tract, and because of that
reason and because these are family members, we have not seen that. The
humanization of pets continues apace.” – PetSmart 2005 Q2 Earnings Call
Transcript
“Yes, David, it's David. We were pleased with the services growth we had for
the quarter. Again, it was driven by the grooming side of the business, and I think
we've continued over the last year to really focus on innovation in our salons.
You are seeing us link some of the merchandising brands that we've had and
bring them into the salons. So, for example, over the last couple of months,
xi
we've had a Bret Michaels top dog grooming package that has a Bret
Michaels bandanna and cologne. We're leveraging our GNC brand, we have
a SPAW package, and that's with the W, that includes GNC Paw Cream and
Very Berry facial wash, where we're rubbing the dog's nose, at the end,
he's clean. And again, I think all of that is indicative of, again, this continued
humanization of pets trend. We are finding that when we bring freshness,
innovative products into our services business, and in grooming in this case,
we're seeing the customer respond. You've seen us with more marketing around
our grooming business, in the Look Great Guarantee in particular. And then I
think we're also starting to integrate services better in terms of the weekend
events that we do as a company, as well as into our circulars, our promo TVs. So
I think it's a lot of smaller things that are all coming together, and we're pleased
with that.” – David Lenhardt, CEO, 2013 Q2 Earnings Call Transcript
“In hard goods, we continue to innovate and differentiate our assortment with
exclusive new partnerships and expanded fresh new assortments. In March, we
added a new line of Disney pet apparel and toys to our portfolio of
exclusive partnerships. And last month, we launched an exclusive clothing
and toy line with Tommy Bahama Pets available exclusively at PetSmart
through August. We're also refreshing the assortments in existing brands
like Bret Michaels Pets Rock with a 1980s retro neon-themed line of
apparel, toys and accessories and in Martha Stewart Pets with seasonal
new assortments like Out at Sea, featuring tropical inspiration sea life
creatures and Camp Martha with outdoor camping inspiration and travel
solutions.” – David Lenhardt, COO, 2013 Q1 Earnings Call Transcript
xii
“We do have a very good database of our customers through our Pet Perks
program. We have about 18 million customers active that we track through
Pet Perks. We have another 12 million that we track through other means.
And so collectively those 30 million-plus customers account for more than
80% of our sales. So we have a very good representative scent of customer
data. And as you mentioned, that has been a capability we have been focused
on for the last three to four years, and have a number of efforts against that from
a CRM perspective today, where we can contact our customers based on your
behavior. And let's say if you are a food service customer who hasn't used
services, we can target you with a services offer. We are partnering with our
vendor today, to help them contact their customers more directly. I think going
forward to the point of personalization, we are starting to integrate online
and the stores better by asking customers. As an example, we've launched,
probably about four months ago, what we call deal alerts. So that as a
customer -- we do a lot of promotions every single month, every single
week -- as a customer with a particular breed, a particular type of product,
xiii
we can curate for you -- if you tell us who that pet is, what you care about -we can curate for you what your offers are, and we can deliver those offers
to you through an e-mail in a customized way. I think that is a very early
example of how we are starting to get into personalization. But this is a
capability that we absolutely are focused on, and you will see us do more of.” –
David Lenhardt, CEO, Goldman Sachs 2013 Conference
“MATTHEW FASSLER , ANALYST , GOLDMAN SACHS: Thanks a lot and
good afternoon. My questions are going to focus on gross margin. First of all, if
you think about the Perks program, it sounds like you're paying a fair amount of
money for some of the sales that you're capturing. So how do you think about the
return on that investment? Are you willing to capture market share while
sacrificing profit or do you feel that the business that you're getting is in fact
profitable today or going to be profitable going forward?
xiv
PHILIP FRANCIS [former CEO]: Matt, this is Phil, and I'll give that one a try. I'm
not quite on board with one of your assumptions. That we're buying business with
Pet Perks. Remember Pet Perks, people hear of a card they often times think of
driving sales via traffic. This is certainly not a traffic draw, this is a spend per pet
kind of program. We use Pet Perks to change behavior and that would be to
either move people up to a more advanced nutrition food from a less
expensive one or to bundle services and service users together from
people who we know are using one service but not another, or in some
cases advanced nutrition food, but no services at all. Or to suggest in a
timely way hard goods purchases that are seasonally appropriate or with
new items. Our goal all along here is profitable sales based upon spend per
pet or average basket size, not to draw traffic. But we think that our program
as it matures while it's still young is a source of profitable sales growth, not
another vehicle for investing margin.
– 2006 Q2 Earnings Call Transcript
“MICHAEL LASSER: But give us the mindset of how your customer looks, how
it's evolved and how it is going to continue to evolve? You know, you have given
us some pretty good parameters on who it is, but what is their mindset when
they're thinking about coming into a PetSmart? Are they just buying product,
maybe adding some items to the basket and leaving? Who and what is it all
about?
xv
DAVE LENHARDT, CEO: You know, they are very passionate customers. Let
me talk a little bit about the third customer initiative I talked about, which is really
focusing on our most valuable customers. And I think we have a very good
understanding of what makes a valuable customer valuable. Specifically, there
are three groups that are our most valuable: customers who purchase
channel-exclusive foods, customers who purchase and use grooming, and
new pet customers -- dog, cat and fish. So we are very focused on building
offerings that are compelling for them, relevant for them, engaging with
them across, again, all three of those segments. We know that those three
types of customers come into our stores more frequently and they spend
more with us than our average customer. So that is an ongoing focus for
us.” – PetSmart 2013 Investor Day
Capital Allocation
PetSmart: The True Cannibal
Share Repurchase
Dividend
$485
$435
$337
$263
$165
$32
2009
$53
2010
$60
2011
$84
2012
$54
2013
PetSmart returned almost $2 billion to shareholders over the last 5 years
-
-
PetSmart target 13-18% long-term return for investors i
o Sales growth between 4% and 6%
 In a market that’s growing at between 3% and 5%
 Growth from
• 2% and 4% comparable store sales
• 2% to 3% square footage growth
o Open 60-80 stores per year
 Including micro stores
o Expect to open 1,700 12,000-18,000 square-feet
stores in the U.S.
o OG&A growth between 3% and 4%
 Total cost growth between 4% and 5%
o => operating income growth between 7% and 12%
o Reinvest 2% - 2.25% of sales into the business
o Return all free cash flow to shareholders
 20% of FCF through dividend
 80% of FCF through share repurchases
o => total 13% – 18% return
Capital allocation is very consistent with the framework
-
o Store footage growth was between 2-3% since 2008
 2009: 3.1%
 2010: 2.9%
 2011: 2.4%
 2012: 2.1%
 2013: 2.3%
o Spent $2,592 million in share repurchases since 2003
 $1,686 million in the last 5 years
 % of shares repurchased was
• 2009: 5.6%
• 2010: 6.3%
• 2011: 6.6%
• 2012: 6.5%
• 2013: 6.3%
 % of shares repurchased, net of shares issued under incentive
plans was
• 2009: 5.2%
• 2010: 4.4%
• 2011: 4.7%
• 2012: 4.3%
• 2013: 4.4%
o PetSmart pay only 20% of FCF in dividend because they consider
themselves a growth company ii
 => repurchasing shares give them more flexibility
o They’re realistic with the growth
 Target 4-6% sales growth
 Don’t think PetSmart will ever return to double-digit growth iii
PetSmart avoids using too much debt iv
o 2.5 Capitalized Debt/EBITDAR v
 From 2004 to 2013, (Net Debt + 8 * Rent)/EBITDAR was about
2.69
• Min: 2.29
• Max: 3.12
• Median: 2.69
• Mean: 2.7
• STDEV: 0.3
• CV: 11%
-
-
 They had higher leverage when they opened new stores
• Max in 2007
 They reduced leverage since 2008
• 2013: 2.29
 Future footage growth is 2-3%
 => we can expect low leverage
Try new store size to reach new markets
o PetSmart keeps its image when build new store models vi
 Similar to Barnes & Noble
 Keep services in the stores
• Adoption
• Vet
• Grooming
 Smaller stores just have few merchandise SKUs
o Open 12,000 square-foot stores to reach areas of smaller population vii
o Open 6,000-6,500 square-foot stores to reach new areas viii
o PetSmart test new store prototype carefully
 Tested the PetsHotel in two stores in 2002
• The result suggested a profitable venture
• => expanded the test to 7 other stores in 2003 ix
• PetSmart opened new hotels slowly because people can
get angry about bad services x
 Opened 12 micro stores in 2013 to see the result
The financial result of hotels seems not to be as PetSmart expected
o PetSmart wanted to have 435 hotels by the end of 2010
 Had only 199 at the end of 2013
o Comments about the hotels doesn’t sound impressive xi
 “the economics of the hotels have been steadily improving”
 “We've been optimizing the labor model with the hotels”
 “we are at a point this year where we are going to be profitable”
 Build smaller hotels going forwards
o But hotels depends on occupancy rate
o PetSmart says hotels were profitable before the crisis
 Hotel can add 99% operating income to existing stores xii
• Profitable in year 2
• Add 29% sales to stores
• Boost pre-tax income by 99%
• Drive additional 4.4% EBIT margin
o From 8% to 12.4% within 5 years xiii
o “A typical PetSmart store with a hotel earns
$879,000 on sales of $7.1 million”
 => 12.4% EBIT margin
 The cost to build a 7,000 square-foot hotel is
about $1 million
 A new store cost $1.1 million
• $0.7 million for fixtures, equipment, etc.
• $0.3 million for inventory
• $0.1 million for opening costs
 => return is 42%
• = 0.879/2.1
• For a 7,000 square-foot hotel xiv
o 30%-40% occupancy rate in the first year of
operation
o At 50-60% occupancy rate => $ 1 million sales
 3 times the rate of EBIT margin of
merchandise sales
o It’s possible that hotel business were impacted by the crisis
o PetSmart has great advantage in the hotel business
 ½ CapEx of freestanding hotel
 Share costs of
• Heating and air conditioning system
• Bathroom
• Parking lot
• Employee break area
• Armor car pickups
• Other overhead
 Competes with small competitors xv
• Best Friends is an East Coast oriented chain
o Freestanding hotels
o 40-50 hotels
• Most competitors are mom-and-pop
o Has one or two hotels
 PetSmart has advantage in getting customers
• Advertising
-
• People going to the stores notice the service
o PetSmart invested about $170 million in 199 hotels
o Investments in hotels can have great return
Lease quality is good
o Terms of lease generally range from 10 to 15 years
 Optional renewal for 2 to 4 5-year terms xvi
o => each lease allows PetSmart to stay from 20 to 40 years
o PetSmart store has high traffic
 Higher visits per square foot than Home Depot
• Sales per square foot
o PetSmart: $246 (2013)
o Home Depot: $$334 (2013)
• Average ticket at Home Depot: $56.78
o => 5.9 visits per square foot
• Average ticket at PetSmart is less than $40
o => higher than 6 visits per square foot
o PetSmart was able to negotiate lower rent expense in recent years xvii
 Other anchors have lower traffic
• Due to online competition
 => PetSmart becomes more important to landlord than in the past
o Rent expense/Sales declined over the last 10 years
 2004: 5.8%
 2009: 5.5%
 2013: 4.8%
o The decline in traffic to all malls because of online wouldn’t be a
problem
 This happens all over the country, not just malls where PetSmart
locates
 Malls can get new anchors to replace lost traffic xviii
• Power centers are signing up
o Off-price retailers of apparels
 TJX
 Ross Stores
o Adding more grocers
 People will build fewer malls
 PetSmart still performed well despite high mall vacancy rate in
recent years
-
• Commercial space vacancy is now higher than normal
o 7.9% in 2013 Q4
 Peaked 9.4% in 2011 Q3
o Between 2003 and 2007, it was about 5.5%
• PetSmart comparable store transactions growth was
o 2007: -0.8%
o 2008: -2.0%
o 2009: -0.3%
o 2010: 2.1%
o 2011: 2.5%
o 2012: 2.4%
o 2013: 0%
• => lower mall traffic doesn’t not necessarily hurt PetSmart
PetSmart is cautious about international expansion xix
“Turning now to our shareholder value framework. Let me orient you a little bit to
the slide. I know that many of you are familiar with this framework, but there are
some updates. The blue boxes are unchanged as is the red box, noting our
13% to 18% annual total yield. The green boxes have all been updated and I
will take you through those updates as I take you through the framework.
Starting at the top line, we are driving sales growth of 4% to 6% in a market
that is healthy and growing, and as David said, is projected to grow 3% to
5%. That assumes that we continue to grow market share each and every
year. The top line sales growth breaks down into 2% to 4% comp store
sales growth plus 2% to 3% square footage growth. As you heard from both
Matt and Bruce, our comp growth will come from innovation and differentiation
and product, services and experiences, while improving our pricing optimization
capabilities. In consumables, the team is focused on expanding naturals in dogs,
accelerating channel exclusive in cats and growing our proprietary and exclusive
assortments. In hard goods, we will capitalize on the newness and innovation
and the fun and fashion and problem solution categories. In specialty, we are
focused on improving the pet parent shopping experience. And as you heard
today, we've just announced our exclusive partnership with National Geographic.
In services, we will continue to differentiate ourselves by building advanced
capabilities to enhance the services experience, while partnering with our
vendors to offer innovative packages and services. Comp growth will also come
from the strength of our nearly 50,000 highly-engaged associates. And as John
outlined we are on this strategy where we are focused on e-commerce, einfluence and building new capabilities. We are enhancing petsmart.com to
continue to grow our online sales profitably, while growing store sales by
i
converting website visitors into in-store customers. As John stated, we see
petsmart.com, the #1 traffic pet supply website as a great opportunity to
monetize our site traffic as a multichannel retailer. We are developing new
capabilities in our PetPerks loyalty program to help us capture and use our pet
parent data better. And finally, through continued innovation in our CRM
program, we will strengthen our relationships with our more than 35 million active
customers via a more personalized and powerful shopping experience. With
respect to our 2% to 3% square footage growth, as we've evolved our store
format to smaller stores, the projected number of net new stores each year
increases to 60 to 80 versus the 40 to 50 we have targeted in the past.
Those are the top line drivers. As you saw on the previous slide, we have a
strong track record of gross margin expansion and OG& A leverage. In our
framework, we are targeting stable to expanding gross margins. We will
achieve this through continued introduction of innovative and proprietary
products and services, as well as by leveraging our occupancy and
warehouse and distribution infrastructure. This is slightly different than how
we presented this before where we have specifically called out stable to
expanding product and services margin. The OG& A growth is targeted at 3%
to 4%. Previously this box refer to cost growth of 4% to 5%, which included
warehouse and distribution and occupancy, both of which are up in gross
margin. These changes better align our framework with our income statement,
which makes the framework more effective as an internal and external tool to
communicate and track performance. When you take the top line sales growth ,
plus the stable to expanding margin and the OG& A cost leverage, it does 2
things for us: it produces earnings before tax growth of 7% to 12%; and
generates operating cash flow in excess of $ 650 million annually. With that
operating cash flow, we'll first reinvest back into the business at
approximately 2% to 2.25% of sales or $ 150 million to $ 170 million
annually. We feel this is the right amount to support new store growth to
maintain our existing portfolio, to drive productivity as well as invest in
technology, our supply chain and other infrastructure to grow the business. With
the remainder of our free cash flow, which is our operating cash flow less capital
expenditures, we are targeting returning 20% of our free cash flow via the
quarterly dividend, stepping up to this level over the next 5 years, with
share repurchases targeted at approximately 80% of free cash flow. All
combined, these results and total shareholder results of 13% to 18%, we
believe that by operating within this framework, we can drive consistent
shareholder returns within this range year in and year out.” – Carrie Teffner,
CFO, 2013 Investor Day
“Gary Balter - Crédit Suisse AG, Research Division: That's why I came, but -somebody -- I'm sure the next question will be on like what happens to traffic, so
ii
I'll leave that for somebody else. Carrie, can you talk about, at the whole
company, the dividend policy? Because we've seen other companies pay 50/ 50,
50% dividend, 50% buyback. And you're 20 dividend and 80% buyback. What's
the thought that goes into that, is there any kind of changing?
Carrie W. Teffner - Chief Financial Officer: Yes. Thank you, it's a great
question. With respect to our dividend policy as we've looked at that
benchmarked against peers, we still consider ourselves a growth company.
And so we do think being on the 20% from a free cash flow, 20 % of free
cash flow in the form of dividends would be -- is appropriate for us. That's
what you're going to get, yes?” – PetSmart 2013 Investor Day
“And thanks, everybody, for coming today. It's great to see many familiar faces
and some new ones. In late 2008 and 2009, we took a hard look at ourselves.
And we're trying to decide what is it we're really trying to accomplish from a
financial perspective. And what are we trying to deliver? And we made a
commitment that we wanted to try and deliver to our shareholder top-quartile
returns, not just in a quarter, not just in a year, but consistently year in and year
out. And so we set out to do that. And we started to fill out a framework to do
that. And then we tried to drive our business to accomplish that. And the
framework's pretty simple. And I'll give you -- walk you through it. We actually
went public with the framework back in our Analyst Day in the fall of 2009. And I
think you can see that we're trying to deliver on that, and we're accomplishing
that task. But, we felt like that we wanted to be a business that was going to
deliver a two to four comp consistently every year, not a six or seven and not a
flat, but something two to four with some years maybe we'll have to lean behind
our backs. And some years, it'll be a little bit more challenging. But, at the end of
the day, how can we deliver that consistently each and every year while at the
same time growing our units 3% to 4%? We feel like we have a runway to do that
and do it consistently without going too fast. If you go too fast, you dilute your
income statement. You're not able to deliver the kind of returns that you want to
do. But, the combination of that is we believe we're a 4% to 7% top line
grower consistently. We're not a double-digit grower anymore and probably
won't be. We would be buying stuff if we so choose to do that. With that, we
also are really working hard to try to keep our product margins stable to
expanding. And it was challenging to do that during the course of the recession,
as Bob alluded to. Our consumables business runs 30 to 35 points, while our
hard goods business runs 65 to 70 points. And during the recession , it was very
difficult because the hard goods or the discretionary items were the things that
were going into the basket. And now we have a very healthy consumables
business. And we have a healthy hard goods business as well. But, it still
becomes challenging because consumables is growing harder or faster than
iii
hard goods. But, we wanted to set out to do that. And we're working diligently to
do it. And we're accomplishing that so far. We also wanted a cost structure
that we could leverage at roughly a 2.5% comp, not just one year or one
quarter, again, but each and every year, which means that if you're going to
grow your stores 3% to 4% more units a year, roughly, your cost
structure's going to increase 4% to 5% each and every year.” – Chip Molloy,
former CFO, Bank of America Merrill Lynch 2011 Conference
“ARAM RUBINSON: That's alright. Just curious to ask around leverage,
because between the acquisition of [DOMANI] and the recap that PETCO just
went through, it seems pretty clear the markets want to support debt on
companies in your business. And I'm not smart enough to suggest the point of
view, but I'm just curious to understand what might hold you guys back from
taking on some leverage on the business.
iv
BOB MORAN, [Former CEO]: Obviously, there's lots of different theories
and lots of different opportunities and there's a lot of inputs as to how we
think about liquidity, how our Board thinks about liquidity and where we
want to be. So it's just an area -- for now I would just say that we don't have
an appetite for -- even though money is cheap, we don't have an appetite to
take on the debt.” – PetSmart, 2010 Q4 Earnings Call Transcript
“Unknown Attendee: One for Carrie. How do you think of financial leverage for
the business? I mean, adjusted debt to EBITDA is around 2.5x, I think. How do
you think about that given everything you've pointed out?
v
Carrie W. Teffner - Chief Financial Officer: Yes. At this point, we think that's
an appropriate level of leverage relative to as we look at the peer set, et
cetera. So we feel comfortable with that level of leverage.” – PetSmart 2013
Investor Day
"I think one of the things we're constantly doing is reevaluating our store
prototype. And one of the things we just talked about last week that we're
going to be testing this year in the first half, we're going to be opening 12,
what we're calling, micro-stores. So these are 6,000 to 7,500 square-foot
stores. Fundamentally -- and they'll be stores that go after new markets for
us. So markets that we think aren't being served with smaller population basis.
That's what it'll enable us to do. Now to do that, we are -- we do need to make
some trade -offs in terms of what's in those stores. So where we focus is
on retaining the brand essence of what PetSmart is. So we believe services
are very important. So you're going to continue to see grooming, training in
the stores. We think adoptions is a big piece of who we are. So you'll see
adoptions in the store. Now you may not see them with the same fixtures
vi
you would see in one of our larger prototypes. And then on the product
side, we think aquatics is really important. So we're going to have fish
systems. But what you'll see is within the product SKUs we're making
trade-offs, and you won't see the full SKU assortment that you would see in
our other prototypes." – David Lenhardt, CFO, Bank of America Merrill Lynch
2013 Conference
“UNIDENTIFIED AUDIENCE MEMBER: Could you guys talk a little bit about
when you're deciding where to put your new stores, can you talk about the
dynamics of the market that you look at? I know that you're looking at some
smaller store formats, and can you just talk about population, square footage,
product assortment, that type of thing?
vii
DAVID LENHARDT, PETSMART CEO: Yes, sure. So, beginning last year our
mix of stores was about 65% of our stores were a smaller concept or smaller
box, roughly 12,000 to 13,000 feet, probably an extra 1,500 feet if it has a
Banfield in it. And this year, 65% of our stores will be that format versus our
more traditional 20K format. What that allows us to do is that allows us to,
one, keep the customer proposition. So, it still has grooming, it still has all
the same SKUs that we have in our more traditional box, and there are
fewer facings, but it still looks and feels like a PetSmart store, very little
difference. So, we can go to market as a PetSmart, and it allows us to go to
markets where you really couldn't make a 20 work from a rent perspective.
So, it's lower rents both on a rate perspective as well as lower rent in
totality because of the sheer smaller square footage. I would tell you that
from a pro forma perspective, as we reviewed those, that the returns on those
are there to four times what we were doing with our vintages in '07, '08 vintages,
and maybe some in '09. The best way I can describe it is those stores are
going into markets that are what I would characterize as tractor supply-like
markets, so it's in smaller fringe of the suburbs, smaller populations. We do
have them in some small towns, Grand Isle, Nebraska, Hot Springs, Arkansas,
Beckley, West Virginia. So, those are pretty small markets and we're pretty
excited about those just from a returns perspective. And now we're into our first
fully year, we're looking at the ramps and they seem to be holding everything we
thought they were going to do.” – Bank of America Merrill Lynch 2012
Conference
“They are 6000 to 6500 square-foot stores branded PetSmart. Overall , our
intent as we have opened them is to expand our overall store runway in
North America today. We believe we have 1700 store runway today, which
is our 12,000 and 18,000 square-foot prototypes. Our 6000 square-foot micro
stores are not included in that store potential. We just opened the 12. They are
viii
in smaller markets, so typically markets with 20,000 to 40,000 households;
typically markets where we're the only pet player in the town. We are
typically located in the main shopping node. Typically, there may be a
Walmart there. We now have a pretty good sense having opened them about
the sales demand that we see there. We have continued to optimize our
operating model, and we feel like this is a very attractive prototype for us
that you are now going to see us this year expand to opening 18 to 24 of
them. In addition to opening them in small markets, we do think that they
can play a role in infill markets for us. Suburbs of Boston is an example
where real estate, to put a 12,000 square-foot store doesn't exist in many
occasions where we would love to put a store there . The 6000 square-foot
format now allows us to get into some of those places and infill where we
haven't had that opportunity before. So we are excited about it." – David
Lenhardt, CFO, UBS 2014 Conference
“Pet services continue to be an engine of profitable growth. With our grooming
and training businesses growing at nearly 30 percent a year for the past two
years, we're now testing new service adjacencies. Initial test results in two
stores of a boarding and daycare business called PETsMART
PETsHOTEL™ suggest we may have found a profitable venture that can
expand the trading area and drive growth in other services. In fact, we’re
confident enough in the PETsHOTEL concept to expand the test in 2003,
with seven new hotels in key markets.” – PetSmart 2002 Annual Report
ix
x
“Today, the inside of the store looks a lot homier, with a little blue shingled area
inside with brick and siding that houses the hotel and day care area. Inside the
hotel section, visitors are greeted to slate tiles and wooden reception desk. In the
dog area, owners can choose between regular boarding, where dogs congregate
in a big room and then sleep alone in kennels, or private suites with raised
platform beds and televisions airing the Animal Planet cable network and other
pet programming. Since the stores are in strip malls, the company developed a
porous pebble floor where the dogs could urinate. There's also a "bone phone"
that allows owners to call in and talk to their pets. Cats have quarters with
separate air filtration systems so their smell doesn't drive the dogs crazy. The
cats also get to watch a live fish tank.
Francis says he can add a pet hotel to an existing location for less than half
the cost of building a similar standalone location. Plus, the hotel shares the
cost of the heating and air conditioning system, parking lot, employee
break area, armor car pickups, and other overhead. Overnight stays start at
$21 a night, $31 for a suite. Day care starts at $14 a day. After five years the
hotels can help boost a store's sales by 29% and double its profitability, both
because the hotels are a high-margin business and because customers come
more frequently and buy other things when they do. A typical PetSmart store
with a hotel earns $879,000 on sales of $7.1 million.
Even with numbers such as those, Francis says he's rolling out the hotel
concepts slowly. They're in just 62 of the stores today, although Francis
says they could ultimately be in 435 stores, or 40% of the chain, by 2010.
He's taking it slow because "people get angrier about bad service than a
bad product. It's more personal. We have to make sure we get it right."” –
The Battle to Be Top Dog, Christopher Palmeri, Business Week, 05 August 2007
“DAVID LENHARDT: That's right. But the economics of the hotels have
been steadily improving. This year, in 2012, we've got 192 hotels as a
portfolio. They are going to be profitable. I mean, that's really been a focus
for us over the last several years. We've been optimizing the labor model
with the hotels. That is clearly the biggest cost. So, we have continued to
tweak that and optimize the ratio of staff-to-guest, and that sort of thing,
and we are at a point this year where we are going to be profitable. As we
continue to grow with the hotels, you will see some leverage. It's a semi-fixed
type of a business in terms of the occupancy and what it drives with labor. But I
think our focus now is absolutely continuing to drive the business. I think the call
center -- the call center actually helps in two ways -- from a revenue
perspective, where in the past we might have had people at the front desk
who never picked up the phone or put somebody on hold and never picked
it up or it went to voicemail. We are now answering every one of those calls
, so there is a revenue uplift there. But the other thing is, again, from a
customer experience perspective, we are getting a much better customer
experience out of that. So, I think we will continue to innovate and drive the
revenue side while continuing to optimize cost as appropriate.
xi
CHIP MOLLOY: I would also add in that we learn a lot from the hotels that we
have. We did learn a lot about what we shouldn't do, at least from a build
perspective, so our hotels traditionally have been 7,000 square feet wide
because back in the old phototypes of PetSmart there was a 27K box, and
then beginning in the early 2000 it was a 20K box. So, you had a bunch of
stores who had an extra 7,000 square feet, and that's why our hotels were
7,000 square feet. The ones that we are building now are actually
significantly lower, more in the 4,000 to 4,500 square feet . We have taken
out other things within the hotels that the consumer is not willing to pay for
from a nicety perspective, although it's still an incredible experience in
there. And we are actually looking at potentially even smaller than 4,000
square feet going forward.” – Bank of America Merrill Lynch 2012 Conference
“The Hotel's impact on the store four walls profitability remains consistent and
compelling. We now believe that the Hotel adds 29% to the total revenues of
the store and boosts pretax income by 99%, and drives 440 additional basis
points of pretax margins. Every Hotel has a Day Camp business folded in and
we have seven stores operating Day Camps without a Hotel attached. We have
looked at these two types of businesses and it's clear while the Day Camp is a
good business on its own, it's much more interesting when it's attached to a full
PetsHotel. So we're pursuing a high grade concept that gives our customers the
best of both worlds and fulfills Day Camp's customers' demand for Hotel
services. This new concept is between 5,000 and 5,500 square feet versus
the 7,200 square feet that we have in our traditional hotel. It has between 75
to 90 regular guest rooms and five to eight suites. In addition, it has two to
three playrooms to support the Day Camp businesses. While the lobby is
scaled-down, it offers all the same services, features and amenities as a full
PetsHotel. We're testing this hybrid model in one store in Dallas and we plan to
extend this test to an additional store this year. While it's early in the test, we'll
have the benefit of operating Hotels and Day Camps. We have had the benefit of
operating Hotels and Day Camps for four years. So we feel quite confident in the
potential of the new and slightly condensed version of the PetsHotel. While
overall revenues are lower in the smaller facility, investment costs are also
less. So the profitability of a 5,500 square foot PetsHotel is comparable to a
regular PetsHotel. And because the smaller version requires substantially
less square footage, we can put it into more potential store sites and more
markets. Because this hybrid model is so compelling, we think it can effectively
replace the stand-alone in-store Day Camps that we have planned, with better
revenues and increased profitability. So as we open more Hotels and better
understand the market potential, we now believe that the total buildout is 435
Hotels, well up from our original projection of 300. Of those, about 65% will
be in new or relocated stores, with the remainder in existing stores.” – Robert
Moran, former COO, John Rice 2006 Conference
xii
“Americans have fallen madly in love with their furry friends, and PetSmart is
doing more than its part to help. Already the nation's largest retailer of pet food
and supplies, the company is fast becoming a big-time operator of pet hotels.
xiii
Some 50 of its stores now offer day care and overnight stays for dogs and cats,
and it plans to quintuple that number by 2010. Eventually, the company
announced last week, it will have 435 hotels, up from an earlier target of 300.
That's good news for latch-key pets-and possibly for PetSmart's shares
(ticker: PETM). For whenever one of PetSmart's 850 stores opens a hotel,
its profitability starts to climb measurably; profit margins can expand to
12.4%, from 8%, within five years, the company says.” – Kibbles ‘n’ Ritz, Tom
Sullivan, Barron, 02 October 2006
“Beyond adding new stores to drive its sales results, PETSMART executives
detailed several initiatives to improve the performance of existing stores. One of
the most intriguing of these is the PetsHotel pet boarding concept that was first
introduced in Phoenix two years ago. It was followed by a second unit in Phoenix
in June 2002, and by the end of this year, an additional seven units will be
opened, including another Phoenix location as well as one unit in La Jolla, Ca.,
two in North Carolina and three in Dallas. Next year, boarding services will be
offered at an additional 14 to 16 stores in markets the company did not identify.
xiv
"We feel great about where the PetsHotel is headed," said David Lenhardt,
senior vp of services, strategic planning and business development. He noted
that 75% of customers who had previously boarded a pet elsewhere gave
the PetsHotel higher marks, while 92% said they would use the PetsHotel
service again. If the concept continues to meet with growing consumer
acceptance, PETSMART could be in for a windfall. At 30% to 40% average
occupancy rates during the first year of operation, the approximately 7,000square-foot facilities, which are contained inside stores, generate sales of
$500,000 to $700,000. If projected occupancy levels of 50% to 60% are
achieved once the concept is more established, PetsHotel has the potential
to add annual sales of $1 million to an existing store at three times the rate of
profitability the company enjoys on its core merchandise mix.
In addition, Lenhardt noted that the boarding concept has a halo effect on
the rest of the stores causing sales to increase for other services such as
grooming and training. Those businesses are already growing, and this year
the number of dogs groomed is projected to total 4.4 million compared to 3.6
million last year. In addition, the number of dogs trained this year is projected to
surge to 300,000 from 197,000 last year.” – PetSmart Unleashes Expansion
Plans, Mike Troy, DNS Retailing Today, 27 October 2003
xv
“UNIDENTIFIED AUDIENCE MEMBER: I'm wondering if you could talk a little
bit about the service offering at the hotel business. Who are your primary
competitors? What are the typical price points? How many of your customers
tend to use those services? Those kinds of questions.
PHIL FRANCIS: Lots of questions on hotels. The venture capital rule of North
America kind of vaporized $ 300 million or $ 400 million in the late '90s and the
early 2000s. What's left is a business called Best Friends, which is East
Coast oriented, that has 40 or 50 hotels that are freestanding hotels and
they're alive and well. Other than that, there hasn't been really much that lasted
from the venture funding of those startups. Our competitors tend to be momand-pops, and oneseys and twoseys. When we bought our first hotel alone as
a laboratory, we bought it from people who had actually started and run
AlphaGraphics, and we bought them because they were trying to do smaller
mode services businesses and controlling quality of policies and procedures in
training. And hotel is a smaller mode services business that you need to have
control over. We thought that business would have been started with that in
mind. And indeed it was, and we learned some of that. So the competitors tend
to be oneseys and twoseys, rather than anybody that is big scale. It's a hard
business to do in quantity unless you're pretty good at services and quality
control in small remote kinds of places. It's all our staff, it's all our P& L, we don't
outsource. It's inside our stores. One reason it's effective is because of
extreme capital efficiency, as compared to a freestanding PetsHotel, which
would probably be in secondary real estate. We have about half the CapEx
of one of those, because it's inside a store and it's also in highly visible,
pretty easy to get to real estate. I like to understand why something works
and one reason our hotels work is extreme capital efficiency. And it's also
being bolted into an existing management team , and the bathrooms are
already there and there's already a store director to help the hotel manager
-- that sort of a thing. Price point wise, we would not be cheapest. We try to sell
dog food and cat litter cheapest; we don't try to do services cheapest. I can
describe to you a theoretical thing that probably doesn't actually exist, but if you
find 10 groomers or 10 trainers or 10 hotels, they all had no ties on price points,
that would be unlikely. But we tried to be seventh or eighth, with 10 being most
expensive. We try to be seventh or eighth, not first or second, but we try to have
the best experience, with the seventh highest price point. I think we sell products
based upon their price and the natural type of attributes that you sell services on
quality and the consistency of the experience. And that's how we would think
about pricing and generally is where we're price.” – 2007 Bank of America
Conference
“We lease all our stores, distribution centers, and corporate offices under
noncancelable leases. The terms of the store leases generally range from 10
to 15 years and typically allow us to renew for two to four additional five
year terms. Store leases, excluding renewal options, expire at various
dates through 2026.
xvi
Generally, the leases require payment of property taxes, utilities, common area
maintenance, insurance, and if annual sales at certain stores exceed specified
amounts, provide for additional rents.” – PetSmart 2013 Annual Report
“UNIDENTIFIED AUDIENCE MEMBER, ANALYST: As you look forward in the
balance of this decade and next decade, what do you see is the opportunity to
negotiate lower rents and lower CAM charges? As some of the other noncompeting chains in your centers have fewer customer counts, some of them
start to struggle, may be opportunities to trigger MAC clauses and move as your
destination retailer, and with your growth and your prime AAA tenant, and
whether you stay or move, it seems like there are greater opportunities to reduce
costs while your sales are increasing, and your margins are and will stay very
healthy.
xvii
DAVE LENHARDT, CEO: Yes, we do see it as an opportunity; it has been an
opportunity over the past several years. So that's been something we have
been taking advantage of over the last several years. You are seeing it
reflected in our occupancy expense, which is a element of our overall
gross margin. And so I think we have seen exactly the dynamics you just
mentioned and I'd expect that those will continue.” – Goldman Sachs 2013
Conference
“"In retail, especially in the power center space, people like to talk about the
death of the big box and the fact that there are a lot of retailers that have had to
close their doors," Tichar said. "What people seem to miss is that while there are
some retailers that are slowly going away or that have gone away, the list of
retailers that are looking to grow is far stronger and has much more depth."” –
How Shopping Power Centers Survive A Tough Retail Rout, Investor’s Business
Daily, 12 December 2013
xviii
“Unknown Attendee: Can you talk about your views on international
expansion? Do you plan to go into new markets?
xix
David K. Lenhardt - President and Chief Operating Officer: I think -- first of
all, you've seen us -- I mean, overall , I would say we think we have a lot of
potential and runway in North America, as we just talked about, and our focus is
continue to drive productivity out of our existing stores. Having said that, I would
say, international stuff, we will evaluate. I think international is one of those
things that has been shown again and again that most retailers, at least
U.S. retailers, have not been able to figure out how to do. So we are wary
and, I think, appropriately cautious around that. And so it's something that I
think we evaluate. I think you have seen us through our partnerships with E-mart
in South Korea opportunistically start to partner. And I think that model, which is
a licensing model, is something that we're going to be able to evaluate in South
Korea and potentially could be something in our future. But again, our primary
focus right now is North America and our existing stores. And if we were to ever
do international, it would be way out in our future.” – Bank of America Merrill
Lynch 2013 Conference
Value
Is PetSmart Today Worse than It Was?
EV/EBIT
16.5
13.7
11.5
11.3
9.8
7.7
-
2004
2005
2006
2007
2008
12.0
10.9
9.1
2009
2010
2011
2012
9.5
8.1
2013 Today
EV/EBIT is reaching the lowest level
-
-
Key inputs
o PetSmart’s current share price: $58
o PetSmart’s number of outstanding shares: 99.21 million shares
o Market Cap: $5,754 million
o Net Debt: $218 million
o 21% share of MMI holdings: $350 million
o EV: $5,622 million
PetSmart’s pre-tax owner earnings is $693 million
o EBIT was $693 million
o Pre-tax owner earnings might be higher than EBIT
o 2013 D&A was $22 million higher than CapEx
 D&A: $235 million
 Cash paid for CapEx: $147 million
 Assets acquired using capital lease obligation: $66 million
 => total CapEx is $213 million
o Some of the CapEx was for new stores
o But we couldn’t find a good reason to explain why D&A is higher than
CapEx
o => using EBIT as pre-tax owner earnings
-
PetSmart’s stake in Banfield hospitals is worth $350 million
o PetSmart owns 21% of MMI holdings
 The rest belongs to Mars, incorporated
o MMI operates 837 Banfield hospital
 Mostly in PetSmart store
 1,500 square feet
o MMI grew impressively
 Sales growth over the past 5 years
• 2009: 38%
• 2010: 10%
• 2011: 11%
• 2012: 18%
• 2013: 14%
 EBIT growth over the last 5 years
• 2009: 128%
• 2010: 66%
• 2011: 8%
• 2012: 43%
• 2013: 8%
o MMI dominate the vet care market
 The vet care market is $14.37 billion i
 About 26,000 animal hospitals operating at the end of 2013 ii
 Most animal hospitals are single-site, sole-practitioner facilities
 Two big chains are
• VCA Antech
o 690 hospitals
 Size 4,000 to 6,000 square feet
o $1,418 million sales
 Almost 10% market share
• MMI
o 837 Banfield hospitals
o 1,006 million sales
 7% market share
• Big chains have advantage in
o G&A
o Advertising
 VCA Antech is trading at 13.1 EV/Adjusted EBIT
-
-
 => MMI deserves at least 12 EV/EBIT
• $139 * 12 = $1,668 million
• => 0.21 * $1,668 = $350 million for PetSmart
PetSmart is trading at more than 26% discount to private owner value
o Acquired by Leonard Green & Partners and Texas Pacific Group iii
 $1.8 billion
 In 2006
 Petco rejected $2.04 billion offer from PetSmart
• PetSmart didn’t want to keep Petco’s management
• Petco’s management got a generous severance package iv
o Petco’s CEO would get
 36 months of salaries
 3 times of average bonus for 3 years before a
change of control
 Immediate vesting of all his Petco options
• The reason to reject PetSmart’s offer was “a potentially
lengthy antitrust review”
o 2005 Adjusted EBIT was $141 million
 12.8 times EBIT
• Implies $8,870 million value for PetSmart
o $693 million * 12.8 = 8,870 million
o => 36% discount
 1 – 5,622/8,870 = 36%
o 2005 EBITDA was $219 billion
 8.2 times EBITDA $7,618 million
• Implies
o $929 million * 8.2 = $7,618 million
o => 26% discount
 1 – 5,622/7,618 = 26%
Peers trade at about 13 times pre-tax owner earnings
o Home Depot
 $$80.54 share price
 11.2 EV/EBITDA
 13.01 EV/pre-tax owner earnings
o AutoZone
 $541.15 share price
 10.91 EV/EBITDA
-
 12.04 EV/ pre-tax owner earnings
o VCA Antech
 $34.68 share price
 10.74 EV/EBITDA
 12.96 EV/ pre-tax owner earnings
o MWI Veterinary Supply
 $138.68 share price
 16.14 EV/EBITDA
 16.65 EV/ pre-tax owner earnings
o PetMed Express
 $13.37 share price
 8.12 EV/EBITDA
 8.37 EV/ pre-tax owner earnings
o PetSmart
 $58 share price
 6.05 EV/EBITDA
 8.11 EV/ pre-tax owner earnings
Investors can get adequate return by paying 13 times EBIT for PetSmart
o PetSmart can grow EBIT 7-9% in the next 10 years
o PetSmart will also use FCF to
 Repurchase shares
 Pay dividend
o It’s reasonable to expect cash return gives investors 5-6% annual return
 If the stock trades at 10 EV/EBIT
• After-tax yield is 6.5%
 If the stock trades at 13 EV/EBIT
• After-tax yield is 5%
 If the stock trades at 15 EV/EBIT
• After tax yield is 4.33%
o So, total return is 12-15% over the next 10 years
o If we pay 15 times EBIT today, and the valuation reduce to 10 times
EBIT in 10 years
 Multiple contraction will reduce return by 4%
 => 8-11% net return
o If we pay 13 times EBIT today, and the valuation reduce to 10 times
EBIT in 10 years
 Multiple contraction will reduce return by 2.6%
 => 9.4%-12.4% net return
o If we pay 13 times EBIT today, and the valuation reduce to 10 times
EBIT in 5 years
 Multiple contraction will reduce return by 5.1%
 => 6.9% - 9.9% 5-year expected return
i
According to American Pet Products Association
“According to the American Veterinary Medical Association, the U.S. market for
veterinary services is highly fragmented with more than 53,000 veterinarians
practicing at the end of 2013. We have estimated that there are over 26,000
companion animal hospitals operating at the end of 2013. Although most
animal hospitals are single-site, sole-practitioner facilities, we believe
veterinarians are gravitating toward larger, multi-doctor animal hospitals
that provide state-of-the-art facilities, treatments, methods and
pharmaceuticals to enhance the services they can provide their clients.” –
VCA Antech 2013 Annual Report
ii
“Petco Animal Supplies turned down a more lucrative buyout offer from an
undisclosed pet supply company in favor of a proposed $1.8 billion bid
from private investors with close ties to the retail chain and its
management.
iii
The San Diego pet supplies retailer disclosed the rejected bid, which would
have added roughly $240 million to the potential cash pot for shareholders,
in a regulatory filing yesterday with the U.S. Securities and Exchange
Commission.
The nation's second-largest pet supplies retailer is seeking shareholder approval
for the deal with private equity firms Leonard Green & Partners and Texas Pacific
Group, who were previous owners of Petco.
The firms offered to buy Petco for $29 per share, or 49 percent more than the
stock's closing price of $19.45 on the day before the July 14 acquisition was
announced. The undisclosed rival bidder's final offer was $33 per share, a 70
percent premium, according to the SEC filing.
Petco is obligated to pay the private equity firms a termination fee of $50 million if
the merger agreement is terminated.
Rodney Carter, Petco's chief financial officer, declined to comment yesterday on
the rejected bid or on anything else in the SEC filing. Nor would he comment on
why Petco didn't inform shareholders sooner that there had been a better cash
offer.
“All the disclosure was appropriate,” Carter said. “The document (SEC filing)
speaks for itself.”
PetSmart, the nation's largest pet supplies retailer, has in the past been
considered a potential bidder for Petco. A PetSmart spokesman yesterday said
the company does not comment on merger and acquisition activity.” – Petco
Picks Lower Offer by Private Investors, Penni Crabtree, U~T San Diego, 12
August 2006
“Petco also has granted some of its executives generous severance packages.
For instance, if there is a change of control like a buyout, Petco Chairman and
former Chief Executive Brian Devine is entitled to 36 months of salary;
three times his average annual bonus for the three years immediately
preceding a change of control; and immediate vesting of all his Petco
options, according to Petco filings with the SEC.” – Petco Picks Lower Offer by
Private Investors, Penni Crabtree, U~T San Diego, 12 August 2006
iv
Growth
The Formula for High-Single Digit EBIT Growth
Low
High
12%
7%
7%
5%
2%
3%
Square Footage growth
+ Sales per square foot
growth
+ Margin Expansion
PetSmart targets 7% - 12% earnings growth
-
-
PetSmart can grow square footage at 2-3% in the next 10 years
o PetSmart target 1,700 12,000-18,000 square-foot stores
 Sounds possible
 There are 2,029 power centers in the U.S. i
 PetSmart can open more than that
• They targeted to open 1,000 big-box stores in 1900s
o Then 1,400
o Then 1,600
o Now 1,700
o At the end of 2013, PetSmart has
 1,333 stores
 28,461,000 total square footage
o => open 367 12,000-square foot stores will add 4,404,000 square feet
 => total 32,865,000 square feet
 => about 1.5% annual square footage growth in 10 years
o PetSmart also open 6,500 square-foot stores to reach new areas ii
 Opening 300 6,500 square-foot stores in 10 years will result in
over 2% annual square footage growth
4% is a long-term realistic growth rate for sales per square foot
o External factors
 Spending per pet should grow at the rate of household income
• According to Bureau of Labor Statistics
• Spending on pet is stable between 0.9% and 1.1% of
household spending
o But increased during the crisis
o From 2007 to 2011, household expenditure
remained flat
 But average household spending on pet
increased 4% annually
 2007: $430.8
 2011: $502.05
• Average spending on pet food was very stable
o 2007: $146.88
o 2008: $163.13
o 2009: $168.92
o 2010: $165.2
o 2011: $182.75
• Average spending on pet supplies, services, and vet are
more volatile
o Pet supplies
 2007: $139.06
 2008: $164.01
 2009: $165.83
 2010: $162.51
 2011: $140.90
o Pet services
 2007: $31.68
 2008: $36.77
 2009: $43.36
 2010: $38.87
 2011: $35.72
o Vet services
 2007: $113.18
 2008: $206.96
 2009: $164.74
 2010: $113.52
 2011: $142.6
 Household income can grow 4% in the long run
• Inflation + productivity growth
• => about 4%
 The pet market grew 5% despite the crisis
• 2008: $43.2 billion
• 2013: $55.72 billion
o Grew 5.6% since 2003
 $$32.4 billion
o Internal factors
 PetSmart can gain share in both merchandise and services
• Sell services to merchandise customers
• Services help get new customers to the stores
• PetSmart’s market share was
o In food & supplies
 2006: 12%
 2013: 17%
o In services:
 2006: 9%
 2013: 16%
 PetSmart isn’t just a store
• Figure out new ways to make money overtime
• PetSmart used to have 20,000 - 27,000 square-foot stores
o They switched to smaller format
o => have 7,000 square feet for hotels iii
• PetSmart closed the horse business in 2006 iv
o State Line Tack departments in 180 stores
o => had more space for
 Pet products
 Pet hotels
• In about 80 stores
• Or PetSmart can give more space to the hospital
o Banfield hospitals are about 1,500 square feet
 837 hospitals
 $1,006 million in sales
o VCA Antech hospitals are between 4,000 and 6,000
square feet
 690 hospitals
 $1,418 million in sales
 Service sales has increased as % of sales
• 2001: 4.8%
• 2013: 11.7%
• Service sales was significantly slowed down by the crisis
o Service sales grew over 20% every year from 2000
to 2007
o 2008: 15.8%
o 2009: 9.2%
o 2010: 7.5%
o 2011: 9.1%
o 2012: 9.7%
o 2013: 3.4%
• The last several years weren’t good for consumer services
o Fitness club membership declined
o Visits to Quest diagnostics declined
o Visits to vets declined
 VCA Antech hospital’s same-store orders
declined
• 2008: -4.5%
• 2009: -5.6%
• 2010: -4.4%
• 2011: -3.9%
• 2012: -1.7%
• 2013: -2.3%
 VCA Antech’s number of lab requisitions
• 2006: 16.3%
• 2007: 12.5%
• 2008: 2.1%
• 2009: 0.3%
• 2010: -2.2%
• 2011: 0%
• 2012: 1.8%
• 2013: 2.3%
 PetSmart’s hotels can be great money maker
 PetSmart wanted to have 435 hotels by the end of 2010
• Had only 199 at the end of 2013
 Hotels didn’t seem to contribute much to earnings v
• “the economics of the hotels have been steadily improving”
• “We've been optimizing the labor model with the hotels”
• “we are at a point this year where we are going to be
profitable”
• Build smaller hotels going forwards
 But hotels depends on occupancy rate
 PetSmart says hotels were profitable before the crisis
• Hotel can add 99% operating income to existing stores vi
o Profitable in year 2
o Add 29% sales to stores
o Boost pre-tax income by 99%
o Drive additional 4.4% EBIT margin
 From 8% to 12.4% within 5 years vii
 “A typical PetSmart store with a hotel earns
$879,000 on sales of $7.1 million”
• => 12.4% EBIT margin
• The cost to build a 7,000 square-foot
hotel is about $1 million
• A new store cost $1.1 million
o $0.7 million for fixtures,
equipment, etc.
o $0.3 million for inventory
o $0.1 million for opening costs
• => return is 42%
o = 0.879/2.1
o For a 7,000 square-foot hotel viii
 30%-40% occupancy rate in the first year of
operation
 At 50-60% occupancy rate => $ 1 million sales
• 3 times the rate of EBIT margin of
merchandise sales
 It’s possible that hotel business were impacted by the crisis
 PetSmart has great advantage in the hotel business
• ½ CapEx of freestanding hotel
-
• Share costs of
o Heating and air conditioning system
o Bathroom
o Parking lot
o Employee break area
o Armor car pickups
o Other overhead
• Competes with small competitors ix
o Best Friends is an East Coast oriented chain
 Freestanding hotels
 40-50 hotels
o Most competitors are mom-and-pop
 Has one or two hotels
• PetSmart has advantage in getting customers
o Advertising
o People going to the stores notice the service
 PetSmart can grow services sales and increase revenue per
customer
• In 2011, top 13% of customer accounts for 51% of sales
o Smart with Heart customers
 13% of customers
 51% of sales
 Average 17.8 transactions per year
 Average annual spend: $657
 => Average spend per transaction: $37
o Smart customers
 48% of customers
 41% of sales
 Average 4.1 transactions per year
 Average annual spend: 150
 => Average spend per transaction: $36.6
o Mart customers
 39% of customers
 8% of sales
 Average 1 transaction per year
 Average annual spend: $34
Overall, PetSmart can grow sales by 6 -7%
-
o 2-3% square footage growth
o 4% sales per square foot growth
o The management expect 4-6% growth
 2-3% square footage growth
 2-4% comparable store sales
Operating income can grow 7-9%
o The management target
 4-6% sales growth
• 3-4% SG&A growth
o It’s possible to grow sales faster than SG&A
 Services sales has higher EBIT margin
• About 30% gross margin
• But much lower SG&A
• Most expenses are in labor
o Included in cost of services
o In 5 years
 4% sales growth & 3% SG&A growth => 6% EBIT growth
 5% sales growth & 4% SG&A growth => 7% EBIT growth
 6% sales growth & 5% SG&A growth => 8% EBIT growth
 6% sales growth & 4% SG&A growth => 9.7% EBIT growth
 7% sales growth & 5% SG&A growth => 10.7% EBIT growth
o 7 – 9% operating income growth is realistic
o Village from 2003 to 2013
 Sales grew 5% annually
 Operating income grew 8.2% annually
2013 Economic Impact of Shopping Centers, International council of Shopping
Centers
i
“They are 6000 to 6500 square-foot stores branded PetSmart. Overall, our
intent as we have opened them is to expand our overall store runway in
North America today. We believe we have 1700 store runway today, which
is our 12,000 and 18,000 square-foot prototypes. Our 6000 square-foot micro
stores are not included in that store potential. We just opened the 12. They are
in smaller markets, so typically markets with 20,000 to 40,000 households;
typically markets where we're the only pet player in the town. We are
typically located in the main shopping node. Typically, there may be a WalMart there. We now have a pretty good sense having opened them about the
ii
sales demand that we see there. We have continued to optimize our
operating model, and we feel like this is a very attractive prototype for us
that you are now going to see us this year expand to opening 18 to 24 of
them. In addition to opening them in small markets, we do think that they
can play a role in infill markets for us. Suburbs of Boston is an example
where real estate, to put a 12,000 square-foot store doesn't exist in many
occasions where we would love to put a store there . The 6000 square-foot
format now allows us to get into some of those places and infill where we
haven't had that opportunity before. So we are excited about it." – David
Lenhardt, CFO, UBS 2014 Conference
would also add in that we learn a lot from the hotels that we have. We did
learn a lot about what we shouldn't do, at least from a build perspective, so our
hotels traditionally have been 7,000 square feet wide because back in the
old phototypes of PetSmart there was a 27K box, and then beginning in the
early 2000 it was a 20K box. So, you had a bunch of stores who had an
extra 7,000 square feet, and that's why our hotels were 7,000 square feet.
The ones that we are building now are actually significantly lower, more in
the 4,000 to 4,500 square feet . We have taken out other things within the
hotels that the consumer is not willing to pay for from a nicety perspective,
although it's still an incredible experience in there. And we are actually
looking at potentially even smaller than 4,000 square feet going forward.” –
Chip Molloy, former PetSmart CFO, Bank of America Merrill Lynch 2012
Conference
iii
“I
“Exiting our State Line Tack horse business focuses us on our core pet products
and services business where we can best operate efficiently and best serve our
customers. While the State Line Tack horse business represents 2% of our total
sales in 2006, it is our least profitable category and, as Phil mentioned, it
operates very differently than the rest of the business. We plan to close our
State Line Tack departments in 180 of our stores and use the space to offer
a bigger selection of pet products or to add PetsHotels. In about 100 State
Line Tack stores, we'll replace equine square footage with more products
our customers want. In many of these stores key pet categories are currently
under represented. This shift should improve in-stock and product displays that
we expect to see higher sales and higher gross margin dollars in these stores.
We'll complete the remerchandising as part of our existing plan to refresh 200
stores with our new Eagle II format in 2007 with State Line Tack stores simply
being converted to Eagle II a bit earlier than originally scheduled. So we have the
experience and the dedicated resources to do the work efficiently and with little
disruption to customers and the operations of our stores. All State Line Tack
departments will be completely converted no later than December 1, putting us in
iv
strong position for the holiday season. And we remain on track to complete the
Eagle II remodels in the rest of the chain by the end of 2008. Exiting State Line
Tack also means we can get to our ultimate build out of 435 pet hotels
without the expenses and resources needed to relocate equine
departments. About 80 of our State Line Tack stores are suitable for our
PetsHotel. In 2007, we'll convert five in-store State Line Tack departments
to PetsHotels. Permitting and plans for this remodeling work are already in place
as these projects were on a list of 35 hotels planned for 2007. In the other 75
locations , we'll remerchandise the State Line Tack space with pet products in
2007 and convert them to PetsHotels as part of our planned rollout over the next
few years.” – Timothy Kullman, former PetSmart CFO, 2006 Q4 Earnings Call
Transcript
v
“DAVID LENHARDT: That's right. But the economics of the hotels have
been steadily improving. This year, in 2012, we've got 192 hotels as a
portfolio. They are going to be profitable. I mean, that's really been a focus
for us over the last several years. We've been optimizing the labor model
with the hotels. That is clearly the biggest cost. So, we have continued to
tweak that and optimize the ratio of staff-to-guest, and that sort of thing,
and we are at a point this year where we are going to be profitable. As we
continue to grow with the hotels, you will see some leverage. It's a semi-fixed
type of a business in terms of the occupancy and what it drives with labor. But I
think our focus now is absolutely continuing to drive the business. I think the call
center -- the call center actually helps in two ways -- from a revenue
perspective, where in the past we might have had people at the front desk
who never picked up the phone or put somebody on hold and never picked
it up or it went to voicemail. We are now answering every one of those calls
, so there is a revenue uplift there. But the other thing is, again, from a
customer experience perspective, we are getting a much better customer
experience out of that. So, I think we will continue to innovate and drive the
revenue side while continuing to optimize cost as appropriate.
CHIP MOLLOY: I would also add in that we learn a lot from the hotels that we
have. We did learn a lot about what we shouldn't do, at least from a build
perspective, so our hotels traditionally have been 7,000 square feet wide
because back in the old phototypes of PetSmart there was a 27K box, and
then beginning in the early 2000 it was a 20K box. So, you had a bunch of
stores who had an extra 7,000 square feet, and that's why our hotels were
7,000 square feet. The ones that we are building now are actually
significantly lower, more in the 4,000 to 4,500 square feet . We have taken
out other things within the hotels that the consumer is not willing to pay for
from a nicety perspective, although it's still an incredible experience in
there. And we are actually looking at potentially even smaller than 4,000
square feet going forward.” – Bank of America Merrill Lynch 2012 Conference
“The Hotel's impact on the store four walls profitability remains consistent and
compelling. We now believe that the Hotel adds 29% to the total revenues of
the store and boosts pretax income by 99%, and drives 440 additional basis
points of pretax margins. Every Hotel has a Day Camp business folded in and
we have seven stores operating Day Camps without a Hotel attached. We have
looked at these two types of businesses and it's clear while the Day Camp is a
good business on its own, it's much more interesting when it's attached to a full
PetsHotel. So we're pursuing a high grade concept that gives our customers the
best of both worlds and fulfills Day Camp's customers' demand for Hotel
services. This new concept is between 5,000 and 5,500 square feet versus
the 7,200 square feet that we have in our traditional hotel. It has between 75
to 90 regular guest rooms and five to eight suites. In addition, it has two to
three playrooms to support the Day Camp businesses. While the lobby is
scaled-down, it offers all the same services, features and amenities as a full
PetsHotel. We're testing this hybrid model in one store in Dallas and we plan to
extend this test to an additional store this year. While it's early in the test, we'll
have the benefit of operating Hotels and Day Camps. We have had the benefit of
operating Hotels and Day Camps for four years. So we feel quite confident in the
potential of the new and slightly condensed version of the PetsHotel. While
overall revenues are lower in the smaller facility, investment costs are also
less. So the profitability of a 5,500 square foot PetsHotel is comparable to a
regular PetsHotel. And because the smaller version requires substantially
less square footage, we can put it into more potential store sites and more
markets. Because this hybrid model is so compelling, we think it can effectively
replace the stand-alone in-store Day Camps that we have planned, with better
revenues and increased profitability. So as we open more Hotels and better
understand the market potential, we now believe that the total buildout is 435
Hotels, well up from our original projection of 300. Of those, about 65% will
be in new or relocated stores, with the remainder in existing stores.” – Robert
Moran, former COO, John Rice 2006 Conference
vi
“Americans have fallen madly in love with their furry friends, and PetSmart is
doing more than its part to help. Already the nation's largest retailer of pet food
and supplies, the company is fast becoming a big-time operator of pet hotels.
vii
Some 50 of its stores now offer day care and overnight stays for dogs and cats,
and it plans to quintuple that number by 2010. Eventually, the company
announced last week, it will have 435 hotels, up from an earlier target of 300.
That's good news for latch-key pets-and possibly for PetSmart's shares
(ticker: PETM). For whenever one of PetSmart's 850 stores opens a hotel,
its profitability starts to climb measurably; profit margins can expand to
12.4%, from 8%, within five years, the company says.” – Kibbles ‘n’ Ritz, Tom
Sullivan, Barron, 02 October 2006
“Beyond adding new stores to drive its sales results, PETSMART executives
detailed several initiatives to improve the performance of existing stores. One of
the most intriguing of these is the PetsHotel pet boarding concept that was first
introduced in Phoenix two years ago. It was followed by a second unit in Phoenix
in June 2002, and by the end of this year, an additional seven units will be
opened, including another Phoenix location as well as one unit in La Jolla, Ca.,
two in North Carolina and three in Dallas. Next year, boarding services will be
offered at an additional 14 to 16 stores in markets the company did not identify.
viii
"We feel great about where the PetsHotel is headed," said David Lenhardt,
senior vp of services, strategic planning and business development. He noted
that 75% of customers who had previously boarded a pet elsewhere gave
the PetsHotel higher marks, while 92% said they would use the PetsHotel
service again. If the concept continues to meet with growing consumer
acceptance, PETSMART could be in for a windfall. At 30% to 40% average
occupancy rates during the first year of operation, the approximately 7,000square-foot facilities, which are contained inside stores, generate sales of
$500,000 to $700,000. If projected occupancy levels of 50% to 60% are
achieved once the concept is more established, PetsHotel has the potential
to add annual sales of $1 million to an existing store at three times the rate of
profitability the company enjoys on its core merchandise mix.
In addition, Lenhardt noted that the boarding concept has a halo effect on
the rest of the stores causing sales to increase for other services such as
grooming and training. Those businesses are already growing, and this year
the number of dogs groomed is projected to total 4.4 million compared to 3.6
million last year. In addition, the number of dogs trained this year is projected to
surge to 300,000 from 197,000 last year.” – PetSmart Unleashes Expansion
Plans, Mike Troy, DNS Retailing Today, 27 October 2003
ix
“UNIDENTIFIED AUDIENCE MEMBER: I'm wondering if you could talk a little
bit about the service offering at the hotel business. Who are your primary
competitors? What are the typical price points? How many of your customers
tend to use those services? Those kinds of questions.
PHIL FRANCIS: Lots of questions on hotels. The venture capital rule of North
America kind of vaporized $ 300 million or $ 400 million in the late '90s and the
early 2000s. What's left is a business called Best Friends, which is East
Coast oriented, that has 40 or 50 hotels that are freestanding hotels and
they're alive and well. Other than that, there hasn't been really much that lasted
from the venture funding of those startups. Our competitors tend to be momand-pops, and oneseys and twoseys. When we bought our first hotel alone as
a laboratory, we bought it from people who had actually started and run
AlphaGraphics, and we bought them because they were trying to do smaller
mode services businesses and controlling quality of policies and procedures in
training. And hotel is a smaller mode services business that you need to have
control over. We thought that business would have been started with that in
mind. And indeed it was, and we learned some of that. So the competitors tend
to be oneseys and twoseys, rather than anybody that is big scale. It's a hard
business to do in quantity unless you're pretty good at services and quality
control in small remote kinds of places. It's all our staff, it's all our P& L, we don't
outsource. It's inside our stores. One reason it's effective is because of
extreme capital efficiency, as compared to a freestanding PetsHotel, which
would probably be in secondary real estate. We have about half the CapEx
of one of those, because it's inside a store and it's also in highly visible,
pretty easy to get to real estate. I like to understand why something works
and one reason our hotels work is extreme capital efficiency. And it's also
being bolted into an existing management team , and the bathrooms are
already there and there's already a store director to help the hotel manager
-- that sort of a thing. Price point wise, we would not be cheapest. We try to sell
dog food and cat litter cheapest; we don't try to do services cheapest. I can
describe to you a theoretical thing that probably doesn't actually exist, but if you
find 10 groomers or 10 trainers or 10 hotels, they all had no ties on price points,
that would be unlikely. But we tried to be seventh or eighth, with 10 being most
expensive. We try to be seventh or eighth, not first or second, but we try to have
the best experience, with the seventh highest price point. I think we sell products
based upon their price and the natural type of attributes that you sell services on
quality and the consistency of the experience. And that's how we would think
about pricing and generally is where we're price.” – 2007 Bank of America
Conference
Misjudgments
Why Did Comparable Store Sales Decline?
7.7%
7.0%
6.5%
4.6%
3.5%
3.4%
2.7%
1.2%
1Q'12
2Q'12
3Q'12
4Q'12
1Q'13
2Q'13
3Q'13
4Q'13
1Q'14
-0.6%
Comparable store sales declined 0.6% last quarter
-
Top analyst concerns are
o “"Discount retailers, grocery stores, and premium grocers are all
targeting the pet category. These competitors hold substantial scale
advantages and may choose to price pet consumables as a loss leader
to drive traffic.”
 Why would other stores have scale advantages over PetSmart?
 Only Wal-Mart has bigger scale
 Other stores may attract customers for convenience
 But this is a different set of customer
• PetSmart stores perform well even when they’re in the
same places with Target or Wal-Mart
 PetSmart initially differentiate from competitors by foods
• Now they also differentiate by services
 PetSmart has much bigger market share than 10 years ago
 Why is the concern today bigger than 10 years ago?
• Why was EV/EBIT 10 years ago over 16 compared to
about 8 EV/EBIT today?
-
-
o “E-commerce competitors may cannibalize retail traffic with in-line
pricing, since a growing number of customers may prefer the
convenience of shopping online and receiving the order directly.”
 We do see a subscription model would make sense on the
customer side
• If it works, it’ll be a problem for PetSmart
 But we don’t see how competitors can make money
 But we might be wrong here
 MorningStar analyst agree with us i
 We might be subject to confirmation bias
 We may fall in love with the store experience
• We can be so impressed with the store experience that we
underrate online competition
Comparable store sales declined 0.6% in 2014 Q1
o Comparable store transactions declined 2.2%
o Increasing amount of choices in the pet specialty market ii
 Smaller players that are more focused on natural food has grown
 But mass retailers didn’t gain share iii
o Intensifying online competition
 PetSmart offer more aggressive free shipping
 Live with order online pick up in-store in 19 stores iv
• Will roll out this feature to all store later this quarter
o Smaller stores with a lot of premium foods may offer convenience to
customers
 But pet food & supply purchases are not frequent
 It’s not like the threat of The Fresh Market pose to traditional
grocery stores
 PetSmart with low prices and services can attract customers
• In dense cities, smaller stores have advantages
o Online competition is a problem
 But economics of online sales is still the same v
 PetSmart is continuing omnichannel efforts
 And growing e-commerce will hurt smaller stores first
PetFlow enjoyed great growth
o PetFlow utilizes Facebook marketing vi
 As of June 2014
 PetFlow has
• 2.1 million Facebook fans
• 859.4 thousand people “talking about this”
o According to CommScore, visits to PetFlow was far behind PetSmart
 Q1 2013, total online visits was
• PetSmart: 7,578,000
• Petco: 5,673,000
• 1800pedmeds.com: 1,936,000
• Wag.com: 765,000
• Petflow.com: 593,000
 But in Q1 2014
• PetSmart: 5,389,000
• Petco: 5,775,000
• 1800pedmeds.com: 1,441,000
• Wag.com: 696,000
• Petflow.com: 26,943,000 vii
o Q4 2003: 8,698,000
o Q3 2003: 2,187,000
o Q2 2003: 714,000
• Pet360.com: 1,800,000
• Petfooddirect.com: 796,000
“The threat of e-commerce competition in the pet category has been a
persistent concern for PetSmart, since the majority of pet consumable products
are nonperishable. However, management estimates that e-commerce generates
less than 4% of the industry's revenue, as it is very difficult to profitably
distribute 20- to 50-pound feed bags door to door, given their low
value/weight and dimensions ratio. Consequently, we expect the value of
pet e-commerce will be convenience, rather than price, as the cost of
shipping should continue to curb online retail's ability to profitably
undercut PetSmart's pricing on consumable items for the foreseeable
future. PetSmart is more exposed via other product categories, such as highvalue veterinary medicine and hard goods, but we believe its differentiated
shopping experience (as one of the few places that allows customers to bring
pets), and suite of services will continue to attract valuable traffic to its stores.”
ii
“Gary Balter- Credit Suisse
i
Thank you. You mentioned in the press release and Carrie you just mentioned
again, the competitive environment, but we didn’t hear what’s the discussion of
it? What’s changed in the competitive environment that’s leading to the lower
guidance and leading to some of the steps that Dave talked about to accelerate
business?
David Lenhardt- President & Chief Executive Officer
Gary, its David. I think what we’ve seen is there is an increasing amount of
choices in the pet specialty market, whether that be smaller players that are
now focused on natural food as natural food has grown. We are also
continuing to see intensifying competition online, and given that, we think it’s
really important for us to focus on driving our traffic trends and we think that there
are things we can be doing better, and that’s why we are taking you through
today, those actions that I just outlined very specifically.” – 2014 Q1 Earnings
Call Transcript
iii
“Brian Nagel - Oppenheimer
Hi, good morning. A couple of questions. First off, I want to go back to Gary’s
question about some of the, I guess competitive threats you’ve seen lately. Is
there a way to sort of say break that apart? Is the bigger effect from online
competitors where you’re seeing more of a competitive entry from let’s say the
grocery stores, other pet supply retailers and then even geographically across
the country, there are certain regions that are weaker on that front than others.
Then I will give you my follow-up?
David Lenhardt - President & Chief Executive Officer
Yes Brian, in terms of the geographic, we are not seeing any really big
geographic differences. In terms of looking at the landscape, I would
separate it into the mass and the grocery, and then separate that from the
pet specialty market, which would be the big bar, the big pet superstores,
the independents, these emerging smaller store chains that are focused on
natural food and then online.
If I start with mass and grocery, we’re not seeing much of an impact from
the mass and grocery perspective. We’re really seeing this in the pet
specialty space and again, it’s a world of increasing choices, both brickand-mortar, but also online.” – PetSmart 2014 Q1 Earnings Call Transcript
iv
“Moving to online, we are not satisfied with where we are and we are committed
to expanding our omnichannel capabilities and fully leveraging our e-commerce
presence. We know that online customers are among the most valuable
customers we have, both in the store and online and we believe it is critical to
compete with these customers in the online space more aggressively.
We have already made progress during the first quarter, including completing the
launch of our new website platform and expanding our online in-store availability
feature across all product categories. Additionally, we recently began offering
more aggressive free shipping and site-wide promotions and will launch a newly
re-designed mobile website to drive e-commerce conversion in the second half of
the year.
We are also continuing the acceleration of our omnichannel capabilities, which
we believe are a key differentiating asset that online only players cannot offer.
We are now live with order online pickup in-store in 19 stores and are pleased
with the initial results.
We will begin rolling out this capability to all of our stores later this quarter
beginning in Canada. We will also begin the roll out of mobile devices such as
iPad minis to our stores later this quarter, which will enable our associates to
take extended aisle orders in the store and assist with food selection.” – David
Lenhardt, PetSmart CEO, 2014 Earnings Call Transcript
v
“Matthew Fassler- Goldman Sachs
Thanks a lot and good morning. I have sort of two twined questions if you will on
e-commerce. First of all, if I contextualize your comments on the relevance of the
channel today versus the way you had framed it in prior quarters, it seems like
you are signing more credibility to that channel now as a sustained competitive
act and I guess do you think that the economics of that channel are working
better for your online competition than you would previously have thought or is it
that regardless of that it seems to be a fact of life that you need to deal with?
And then last, my second question is kind of attached to it. Are you seeing any
change in the willingness of some of your better vendors and the higher end
vendors to do business with the online-only players? Thanks a lot.
David Lenhardt - President & Chief Executive Officer
Thanks Matt, and please let me know if I don’t answer all elements of that. To
your first point, we do believe that there is an increasing relevance in terms
of the online channel and we’ve seen that over time and that’s something
that we’ve been monitoring closely.
As I said, we have seen the consumables in particular continue to grow at a
faster rate than the overall online rate, and we think it’s critical for us to
compete for those customers. We know that they are more valuable customers,
both in the store and online.
We also know to your point around economic that the economics of these
customers are less than the overall economics of our business, due to the
fact that food in particular has such a high rate in the economics of
shipping food.
Having said that, that is where our focus on omnichannel capabilities that we
have that the online players do not have are focused for us that we are
accelerating, so very specifically, order online pick-up in store and
ultimately order online shipped from store are ways for us to mitigate those
economic costs. But the reality of those economics of shipping food, which
I would suggest all competitors, all players have to live with continue to be
the case.
In terms of your second question, in terms of our vendors and willingness, I
would say we haven’t seen any big change. I think when you look at kind of the
supply online, there are many ways to get that supply, whether it be direct or
whether it be through distributors. I think that it’s a little bit of a mix in terms of
which vendors are doing what, whether they’re direct or not, but we haven’t
noticed a substantial change there.”
vi
“I’m the co-founder of a company called PetFlow.com, an online retailer of pet
food. We have over 300,000 fans on Facebook on our fan page
at http://www.facebook.com/petflow. We certainly don’t have 300,000 customers
yet, however, we constantly advertise to build our fanbase. For us, our fan page
has been both a great source of ideas, a place where our existing customers can
share their experiences with potential customers, as well as a place where we
constantly generate new customers for our business.
How? We engage our audience! If those top 200 brands only had 1.2%
engagement from their users, look at ours:
Over 20% of our users have interacted with us in some way in the last
week, by commenting on a photo of a cute animal that we post, by
commenting on a question that we’ve asked, or by participating in some
sort of promotion. Every single day, we post about 8-10 times and ask our
fans to comment on our posts, like them, and express their opinion, and
they do! We also hold many contests on our fan page, asking users to jump
onto our site at www.PetFlow.com, find a product that they like, and post a link to
that product in a response – and we then pick a winner of the contest, and give
them $20-$30 worth of products for free. But guess what? After thousands of
people visit our site and see our prices by browsing products – we get
customers!” – PetFlow Founder Says Brands Don’t Know FaceBook, Alex
Zhardanovsky, Performance Marketing Insider, 5 February 2012
“Over the last several years, a number of online-only pet products retailers have
entered the market, including 1800petmeds.com and pet360.com. While these
retailers still represent a small percentage of the overall visits to pet retailers’
sites, they have been experiencing rapid growth. It should be noted that
Petflow.com has experienced a huge influx of web traffic as a result of
posting videos on Facebook that have gone viral.” – UBS Investment
Research on PetSmart, 19 May 2014
vii
Conclusion
PetSmart Is a Good Investment Candidate for Warren Buffett
Sales Growth
Earnings Growth
Shareholders Return
15%
12%
9%
7%
6%
4%
Low
High
PetSmart promise 12%-15% long-term return
-
-
Has lowest risk among the companies we look at so far
o Life Time Fitness has risk in capital allocation
 The CEO mismanaged his personal finance
o CLUB and WTW have debt problem
 WTW is in a turnaround
 CLUB has huge fixed cost with short-term problems
o Car-Mart face a risk that they can’t control
 Securitization
• The risk seem remote, but if it happens, it can kill the
business
o The biggest change PetSmart faces is online competition
PetSmart can have very consistent growth
o Doesn’t have as high potential as Life Time Fitness or Car-Mart or even
Tandy Leather
o But the industry has good future
o PetSmart isn’t just a retailer
 Core strength:
• Store traffic
• Brand images
-
-
• Scale
 They can reinvent themselves
• Or can replicate new ideas to their stores
 Spending mix for pet might change
• Just like human
• PetSmart is in the best position to take advantage of
favorable trends
o Growth in services can result in margin expansion
o PetSmart can have high single digit earnings growth for many years
If we don’t think online will kill the business it’s obvious that PetSmart is
undervalued
o PetSmart’s capital allocation is extremely predictable
 Investors may expect 5-6% from cash return
o Sales can grow 6-7%
 => earnings can grow 7-9%
o => 12-15% long-term return is a good investment
o Even PetSmart’s earnings grow at pet market growth rate
 4-5%
 => 9-11% long-term return
Petsmart is a perfect candidate for Warren Buffett to buy