What a brutal six months it’s been for Petco. The stock has dropped 25.8% and now trades at $3.19, rattling many shareholders. This may have investors wondering how to approach the situation.
Is now the time to buy Petco, or should you be careful about including it in your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Is Petco Not Exciting?
Even with the cheaper entry price, we're cautious about Petco. Here are three reasons why we avoid WOOF and a stock we'd rather own.
1. Same-Store Sales Falling Behind Peers
Same-store sales is a key performance indicator used to measure organic growth at brick-and-mortar shops for at least a year.
Petco’s demand within its existing locations has been relatively stable over the last two years but was below most retailers. On average, the company’s same-store sales have grown by 1.1% per year.
2. Operating Losses Sound the Alarms
Operating margin is an important measure of profitability for retailers as it accounts for all expenses necessary to run a store, including wages, inventory, rent, advertising, and other administrative costs.
Although Petco was profitable this quarter from an operational perspective, it’s generally struggled over a longer time period. Its expensive cost structure has contributed to an average operating margin of negative 9.5% over the last two years. Despite the consumer retail industry’s secular decline, unprofitable public companies are few and far between. It’s unfortunate that Petco was one of them.
3. High Debt Levels Increase Risk
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Petco’s $2.93 billion of debt exceeds the $165.8 million of cash on its balance sheet. Furthermore, its 8× net-debt-to-EBITDA ratio (based on its EBITDA of $336.5 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Petco could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope Petco can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
Petco isn’t a terrible business, but it doesn’t pass our quality test. Following the recent decline, the stock trades at 52.2× forward P/E (or $3.19 per share). This valuation tells us a lot of optimism is priced in - we think there are better opportunities elsewhere. We’d suggest looking at a top digital advertising platform riding the creator economy.
Stocks We Would Buy Instead of Petco
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