Over the last six months, Petco’s shares have sunk to $2.79, producing a disappointing 10.4% loss - a stark contrast to the S&P 500’s 7.9% gain. This might have investors contemplating their next move.
Is now the time to buy Petco, or should you be careful about including it in your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Do We Think Petco Will Underperform?
Even with the cheaper entry price, we're sitting this one out for now. Here are three reasons why WOOF doesn't excite us and a stock we'd rather own.
1. Flat Same-Store Sales Indicate Weak Demand
Same-store sales show the change in sales for a retailer's e-commerce platform and brick-and-mortar shops that have existed for at least a year. This is a key performance indicator because it measures organic growth.
Petco’s demand within its existing locations has barely increased over the last two years as its same-store sales were flat.
2. EPS Trending Down
We track the long-term change in earnings per share (EPS) because it highlights whether a company’s growth is profitable.
Sadly for Petco, its EPS declined by 38.6% annually over the last three years while its revenue was flat. This tells us the company struggled because its fixed cost base made it difficult to adjust to choppy demand.
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 $2.86 billion of debt exceeds the $256.7 million of cash on its balance sheet. Furthermore, its 6× net-debt-to-EBITDA ratio (based on its EBITDA of $408.2 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 falls short of our quality standards. After the recent drawdown, the stock trades at 11.9× forward P/E (or $2.79 per share). This multiple tells us a lot of good news is priced in - we think other companies feature superior fundamentals at the moment. Let us point you toward one of Charlie Munger’s all-time favorite businesses.
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