I first thought about looking into PetMeds when I realized my family has been loyal customers (thanks to our pooches) for years. I’ve liked PetMeds for some time now, and I owned shares from back in June of 2005 to around the same time in 2006, selling only when I thought the runup that year represented an overvaluation.
But before delving into the valuation, I’ll say a bit about what I believe to be a strong company. First and foremost, it has strong presence of mind amongst a large number of (good) pet owners. The company has marketed well to its base, continues to grow that base (e.g. they increased the number of customers by 20% over the last two fiscal years), and does a phenomenal job of retaining that base with superb customer service (helpful hint if you ever order from them: they WILL beat any competitor’s price).
Though competition seems fierce (emphasis on the “seems”) with tons of knockoffs (nextdaypets.com, medi-vet.com, petrx.com, and on and on), there is really no company nearly as successful as PetMeds in its business model. The company is actually competing mostly with veterinarians, who arguably have a built-in advantage as a face-to-face “trustworthy” source. But as more and more pet owners become acquainted with PetMeds, its customer service, and its great prices, they’re making the switch, and they’re sticking with it.
Now to the nitty-gritty. Most importantly, PetMeds is financed very conservatively (basically no debt) and earns tremendous returns on its equity base. It is not a capital intensive business by any stretch of the imagination, and for a retailing operation, its margins are above-average. Notably, its competitors have yet to diminish the returns that PetMeds is earning, and the company’s management has been successful in employing the incremental capital at these high returns. PETS has lots of free, and growing, cashflow.
Assuming a 12% cost of capital (probably conservative) and a 10 year growth rate of 13% followed by continuing returns of 5% (certainly feasible, and I argue likely), a quick DCF analysis gives a value for the company of $365 million. Currently trading at a market cap of $317 million, this doesn’t represent a huge margin of safety, but its a reasonable figure and gives us plenty of reason to put it on the watch list in case the stock falls a bit in price.
In the end, though, the margin of safety will probably be the strength of the company and its ability to construct Warren Buffett’s famous “moat” around its business. It has done well to that end to date, and if it continues, we have ourselves a bargain.
Note: The author does not currently hold a position in any stocks mentioned in this article.