My infatuation with technology, internet, and social media companies has passed for the most part. I rarely pay attention to any of them. I will admit to keeping one eye on Google and Amazon. Google has a moat that isn't easily overcome. Amazon is really a low cost retailer that interacts with it's customers through the internet. Let me restate that, Amazon is THE low cost retailer, the Walmart of the internet, so to speak. All that being said, you must be asking yourself “Why in the hell is he writing a blog about Pet Med Express?”. Let me give you some background on how I ended up here, writing this.
As many of you know at StockBuz, I use the Vuru website frequently while researching companies. It provides some nice tools and the price is right, free. Anyway while visiting the site and scanning the discussion area, I came across a post by user Alexleroi about Pet Med Express (PETS). Generally I find that user's posts very insightful. In the post, he pointed out two major issues with PETS. First, PETS has $12.5 million in illiquid auction rate securities that they are booking as assets on their balance sheet. And secondly, they seem to expense their TV advertisements only after they have aired as opposed to expensing them, oh I don't know, when the money is actually spent. My sarcasm is provided free of charge. Here's the link to the actual post and discussion:
http://www.vuru.co/analysis/PETS/discussion
Well, since I don't fall into the “it's on the internet, so it must be true” camp, I downloaded the PETS 2011 annual report. I suspected that Alexleroi wasn't making it up. I expected to find both issues as well. Probably buried deep in the fine print of the back pages of the report. Not surprisingly, while reviewing the report I found both of the issues that had been mentioned earlier. What did surprise me was how honest PETS was about it. Each issue is mentioned throughout the report, not just the fine print on the last few pages. Anyone who read half of the report(it's not very long) would be aware of the auction rate securities and the expense as they are broadcast advertisements.
http://investor-relations.petmeds.com/petmeds-annual-report-2011/PetMedExpress2011AnnualReport.pdf
Now some of you must be thinking PETS should be commended, at least in some small way, for being brutally honest. Well just because they were honest on both issues doesn't make either issue correct. In fact their honesty only guarantees that they will not have as big a fine to pay the SEC, later, when they will probably be forced to restate several years of earnings. Though I can't say this with absolute certainty (I refuse to spend that much time and research on this company!lol), PETS probably is massaging the earnings numbers because the executives are in some way compensated based on earnings.
Another observer might conclude that they are simply trying to smooth out lumpy earnings and will take the write-down on the ARS's when earnings have a significant increase. The logic of that argument is seriously flawed. They are essentially a small, internet based veterinary pharmacy. They offer nothing that can't be found elsewhere. They can't compete on price because they do not have the economies of scale that a Walmart or Walgreen has. All they have is name recognition and maybe a small loyal customer base. Honestly I may be reaching on both counts. Growing earnings consistently in the future is probably a pipe dream. Even maintaining it's current level may prove a feat to far. In my opinion the company is a deteriorating asset whose only hope is to be bought by a bigger player at some point in the future.
Looking further into the company, in my opinion, the executives are slowly bleeding the company dry. They initiate a dividend of $.60 a share while net income has fallen roughly 36% over the past 3 years; from roughly $26 million to $16.7 million. The payout ratio is 76%. A ratio that high may be sustainable and healthy for a large, slow growing utility like Consolidated Edison. For a small company in a competitive field with shrinking margins, a ratio that high is neither healthy or sustainable. You take into account the $12.5 million in illiquid auction rate securities which yield a paltry .80%(assuming no defaults), well below the current low inflation rate, and alarms really start to go off. If net income continues to fall they will have to cut or eliminate the dividend. Financing the dividend may prove difficult for a company of this size, though they do have very little debt on their balance sheet.
In conclusion, if PETS is not a great example of hiding something out in the open, I'm not sure what would qualify. Their example is also solid proof that most of Wall Street does not read the annual or quarterly reports. If Wall Street actually did read the financials, PETS would not be trading at 4x book with nearly 80% of the float held by institutions. One caveat 28% of the float is held short, so at least 10% of the institutions' positions are actually short, though, I'm certain the Fidelity Low Priced Stock Fund and various Vanguard Index funds do not hold short positions. Between the Fidelity fund and the Vanguard Index funds, they collectively own 18+% of the float. Not exactly a shining endorsement for passive or active management in the mutual fund universe, is it? But that's another discussion entirely. PETS, on the surface may appear to be a solid value play. Once some basic research is completed, a rational investor will come to a different conclusion. Stay away, at best it is a deteriorating asset. At worst, PETS is a shell game that will only enrich management at the expense of shareholders.
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