PetSmart, Inc. Analysts Respond To Jana Partners

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PetSmart, Inc. (NASDAQ:PETM) has issued a statement regarding Jana Partners’ disclosure earlier today. It’s a typical, run-of-the mill sort of statement:

“PetSmart welcomes open communications with its shareholders and values constructive input toward the goal of enhancing shareholder value,” a company spokesperson said in an emailed statement to ValueWalk. “Our Board and management team are committed to creating value for all PetSmart shareholders, and we will continue to take actions to accomplish this goal and position the Company for growth and success.”

Analysts from multiple firms are also weighing in on Jana Partners’ disclosure today. The firm disclosed a 9.9% stake in the pet care retail chain and said it seeks to enhance shareholder value. All of that stake was likely acquired during the June quarter because there was no position reported in the firm’s March quarter filing.

PetSmart “invited” activist intention

In a report dated today, Raymond James analyst Dan Wewer said shares of PetSmart had fallen to “levels that tend to attract activist shareholders.” The retail chain’s EV / EBITDA multiple was only 6.5 times, while its free cash flow yield was 7.8% and its P / E multiple was 13.6%. All multiples are based on 2014 fiscal year estimates. Wewer said the company’s low valuation reflects its “deteriorating top-line growth prospects,” which he thinks demonstrates that PetSmart faces greater and greater challenges in growing its market share.

He noted further that the company has seen its customer traffic decline because of its “aging store base” and increasing competition from online retailers. He said PetSmart management was too slow to address the threat from ecommerce and reminds investors that the retail chain’s president, CEO and chief financial officer have all left within the last year.

Wewer has a Market Perform rating on PetSmart.

Possibilities for PetSmart

In another report dated today, JPMorgan analysts Christopher Horvers, Mark Becks and Leslie Elder offered a few possible options. They note that PetSmart increased its capital expenditures to between $150 million and $160 million recently due to investments in IT and ecommerce. The company also increased unit growth, planning to open about 60 units this year. The JPMorgan team estimates that this will contribute about $30 million to capital spending. They note that most retail investors aren’t interested in opening more stores because of how quickly online spending is increasing.

In terms of leverage, they estimate that PetSmart has gross debt to EBITDAR of 2.5 times, including capital leases. They say each turn of EBITDAR is about $1.25 billion, which adds half a turn of leverage to a share buyback, representing about 9% of the retail chain’s market capitalization at today’s share price.

Likely and unlikely paths for PetSmart

The JPMorgan team doesn’t think a sale of PetSmart is likely because no strategic buyer is immediately apparent to them. They note that vertical integration causes conflicts with other brands and that PetSmart is the market’s biggest player. They also say that investors have been considering whether PetSmart will buy competitor Petco.

The analysts suggest that it’s possible PetSmart will go private through a leveraged buyout and then merge with Petco at some point in the future. They say there are a couple of issues though, like the large number of crossover stores. Also Petco did have a mid-single digit higher price structure than PetSmart, which they believe could cut down some of the synergies of a merger.

On a side note, they say by merging, the companies might be able to negotiate better pricing from vendors compared to online only players. The JPMorgan team has a Neutral rating on PetSmart.

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