Petco’s stock price has taken a beating over the past six months, shedding 29.8% of its value and falling to $2.54 per share. 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 though the stock has become cheaper, we're cautious about Petco. Here are three reasons we avoid WOOF and a stock we'd rather own.
1. Flat Same-Store Sales Indicate Weak Demand
Same-store sales is a key performance indicator used to measure organic growth at brick-and-mortar shops for at least a year.
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
Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.
Sadly for Petco, its EPS declined by 42% 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
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.
Petco’s $2.97 billion of debt exceeds the $237.4 million of cash on its balance sheet. Furthermore, its 7× net-debt-to-EBITDA ratio (based on its EBITDA of $398 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 doesn’t pass our quality test. After the recent drawdown, the stock trades at 11.2× forward P/E (or $2.54 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - you can find more timely opportunities elsewhere. We’d recommend looking at a dominant Aerospace business that has perfected its M&A strategy.
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