Petco Health and Wellness NASDAQ: WOOF it is a misunderstood company in the midst of change, with signs of drag. It faces competition from companies like Chewy NASDAQ: CHWYIts digital services and automated shipping are relevant to consumers, but they are not out of the game.
The transformation is focused on five key areas: products, services, private labels, digitization, and balancing store inventory.
The net result is improved results, including a return to positive comps, and a positive free cash flow outlook for the foreseeable future.
Free cash flow is a sore point in this market. Petco was struggling before its IPO and suffering in a high interest rate environment. Debt retention significantly reduces cash flow, but it is a problem that managers are working on.
Q1 results reflected that performance, including a year-over-year improvement in cash flow and a decline in debt. Debt remains high but is expected to continue to fall in the coming quarters.
Petco Recovers Traction in Q1, Reaffirms Guidance
Petco’s Q1 results were mixed compared to analysts’ forecasts, with revenue slightly above forecasts and GAAP earnings well below. Key data included growth in total system sales, which was reported as 0.2% despite the closing of a number of stores. Store closures will continue to be a problem this year, impacting overall growth by 550 basis points over time.
The most important detail was the same store sales, which is also good. Comp sales increased by 0.7%, supported by the expansion of services.
Service expansion is a cornerstone of Petco’s turnaround strategy. Not only does it differentiate itself from digital operations like Chewy, but it also provides opportunities for cross-selling while shoppers are in-store. Other pillars include fresh and frozen foods and private label entry. Both provide revenue streams and margins, which are important in the context of debt reduction. Additionally, Petco is working to unlock cash flow during sales by streamlining and improving both in-store and digital operations.
Margin news was good. The company increased its gross margin and performance, evidence of fundamental improvement. The only bad news is that debt costs continue to overshadow cash flow and profitability, leading to a net loss and negative cash flow for the quarter.
Looking ahead, the direction is a test, the expectation is that the strength will continue in the future. Full year sales growth guidance has been reaffirmed at 0.75%, which will ensure business flexibility if achieved. Longer term, growth is expected to accelerate as store closings slow and Comp store sales improve.
Analysts and Institutions Limit Risk, Point to Double Digits Above
Analyst and institutional trends indicate optimism in Petco’s turnaround and confidence in its future. MarketBeat tracks 12 analysts who rate the stock at consensus hold, with a target of 40%. Although the 12 analysts covering the name is a relatively small number, it is sufficient for an average level of belief, as seen in the institutional ownership. They own nearly 95% of the stock and have been accumulating shares as the price has fallen in long-term declines.
The price action of the chart shows high institutional ownership and accumulation. Market action has traded sideways within a narrow range for years, bouncing multiple times from the low end. The likely outcome is that the market will continue to trade within this range until concrete evidence emerges that the reversal will hold.
Insiders Will Limit Upside as Prices Return to Highs
Something to note about Petco’s institutional ownership is that about half is owned by a single business. Scoobie Aggregator is a joint venture that owned the company before its IPO. It was covering the position when the shares traded at high levels but was stopped in late 2021. The danger is that the Scoobie Aggregator uses pricing power to take money off the table, but that doesn’t happen until stocks return to much higher price points. Short interest is not a major threat at this time.
This year’s risks include rising fuel costs, tax exposure, consumer trends, competition, and execution. Gasoline costs are not only hurting consumers but have been reducing Petco’s operating life. It has exposure to inbound and outbound shipments in its distribution centers, but it is limited in many ways. Another is Break Through Fuel, a digital platform that optimizes fuel fines based on consumption rather than minimum levels.
Competition may be a major obstacle in this market. Petco operates in a tough market, competing with big retailers like Walmart NYSE: WMT and pure niche retailers such as Chewy and PetSmart. PetSmart is a direct competitor, operating in the same market space. It, too, is switching to a service-oriented pet lifestyle to battle online competitors.
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