Petco Health and Wellness (WOOF) is in a perfect place for a complete turnaround situation. An integrated approach to pet care has several benefits including, convenience and cost. The company faces stiff competition from the industry foes, Chewy and PetSmart. If Petco can reduce some of its debt, which is weighing on earnings, and execute better on costs, it can become quite profitable and may offer some value. The overall pet market remains very robust, as owners look to humanize their pets, and personalization becomes an important feature of pet services. Additionally, the radicalization of pet ownership has drastically increased since lockdowns have been implemented. Petco offers a one-stop shop solution to grow with the recent pet adoptions.
Petco is a pet health and wellness company that provides a range of pet healthcare supplies, veterinary services, insurance, and grooming services. The company has over 1,500 locations across the U.S, Mexico, and Puerto Rico.
The company offers an integrated solution to its customers, particularly veterinary services. The company is relying on an increasing number of pets and the personalization of those pets as the key to its business. The U.S. pet care market currently stands at $100 billion, and the global market is expected to grow to $350 million by 2027. The pet market offers up a lot of opportunities for growth, but issues remain with management, as they haven't been able to keep Petco profitable. One way in which Petco is set to benefit from the growth is by offering its integrated services. Beyond its integrated services at its physical location, digital growth, in particular, saw explosive growth witnessing more than a 100% increase in 2021.
The integrated omnichannel approach, which includes clinics and hospitals, mobile centers, and online services, has served the company well during COVID, which provided a tailwind to its business. The company has stated that the trend will likely continue into 2021.
Petco continues to face issues with its margins, and gross margins have continued to decrease during the quarter. The company is looking to turn the situation around, and I don’t expect it to be much of an issue moving forward, but management’s ability to improve profitability is key. The company historically has had issues with profitability and taking on too much debt. In 2020, Petco reduced its net debt by $1.5 billion, and now the company has a total net debt of $1.5 billion. And with revenue improving, 2021 should see Petco perform much better than it did in 2020. Beyond the company's historical issues, it also faces strong competition. Competitors such as PetSmart have also started to offer integrated solutions, which will affect revenue moving forward. I'll be watching for the management's strategy to turn the company's fortunes around and get to profitability.
Competitors continue to enter the integrated pet wellness market and the industry is getting only more and more competitive. The increase in competitors will be an issue and will put pressure on margins moving forward. In the longer-term, things should consolidate, as fewer players remain in the market and the bigger players gain market share. Management's ability to weather the competition and get to a point of profitability remains to be seen.
Net revenue grew by 16% in the latest quarter, as digital services and COVID-related services provided a tailwind. Some of the drops in gross profits came from COVID-related costs mainly materials, etc., and these costs should reduce in 2021. The company also has been making incremental investments into acquiring new customers, although there was a slight drop in operating costs regardless, which meant operating profits Y/Y.
Overall, volume growth and cost management will be the biggest factors for the company as it looks to head towards becoming more profitable in 2021. Furthermore, I expect net revenue to increase by 14-15% again in 2021, as digital sales and an increase in locations continue to push revenue up further. I also believe products such as pet insurance will become a key source of revenue growth moving forward. The fall in debt combined with improved margins should help the company towards slight profitability in 2021, and then beyond into 2022, the company is likely to see reasonable profitability levels.
Price to Sales currently trades at 1.3, and Price to Book currently is at 2.72. EV/EBITDA stands at 23x. All these metrics point to a stock that may not be as overvalued as the stock price indicates. Regardless, the company's history of being unprofitable means the stock will remain subdued until profitability issues are resolved. I do believe it will head towards profitability more substantially in 2022. Meanwhile, in 2021, the company could probably squeeze out a 3% profit margin which would put the P/E at 30x forward earnings. Therefore, at this point, I think the stock is probably fairly valued. Compared to Chewy, which has a 5x P/S, the company is priced a lot more reasonably.
Petco has favorable industry dynamics, as pets become an ever more important part of society. The company will continue to make improvements into 2021, as it looks to become profitable. As debt continues to fall, and costs continue to fall, Petco may finally be able to get to profitability.
Current Price: $21.64
Estimated Price Target: $32.50
Timeframe: 2021 EOY/Q1 2022
Upside Potential: +50%