A Member of Pat McKeough’s Inner Circle recently asked for his advice on an online pharmacy company that sells veterinary medicines for your pets.
Pat likes the firm’s increasing revenues and customer growth numbers, as well as the 3.5% yield after the latest dividend increase. However, Pat warns that profit margins have been squeezed by increased competition despite the online pet market’s overall strength.
Q: Hello, Pat. Do you have any information about a drug company called PetMed Express (PETS on Nasdaq)? Best wishes and thanks.
PetMed Express (Symbol PETS on Nasdaq; www.1800petmeds.com), is a leading online U.S.-wide pet pharmacy. The company does business as 1-800-PetMeds. It sells prescription and non-prescription medications, and other health-related products, through three main channels: the Internet, telephone contact centres, and direct mail.
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Over the last five years, PetMed’s revenue increased 21.0%, from $234.7 million in fiscal 2016 to $284.1 million in fiscal 2020 (fiscal years end March 31). Earnings improved 25.7%, from $20.6 million ($1.02 a share) in 2016 to $25.9 million ($1.29 a share) in 2020.
However, results from the latest fiscal year were trending down—although there was a big improvement in the latest quarter due to COVID-19.
In the fiscal year ended March 31, 2020, PetMed’s revenue edged up only 0.2%, to $284.1 million from $283.4 million in fiscal 2019. At the same time, earnings fell 31.3%, to $25.9 million, or $1.29 a share, from $37.7 million, or $1.84.
This drop in earnings reflects changes in the market. Last year, Walmart began to sell pet medications online in direct competition with PetMed. Other online competitors include Chewy, Petco, PetCareRx, and VetRxDirect. This increased competition has forced PetMed to cut prices.
As well, the company has increased spending on advertising to stay ahead of the competition. In fiscal 2020, PetMed spent $22.7 million in advertising, up 2.7% from $22.1 million in 2019. The average advertising cost of acquiring a new customer rose 1.9%, to $54 from $47.
Profit margins have been squeezed, but the online pet market is booming. Some 67% of U.S. households now own a pet (compared to 56% in 1988). Americans spent $95.7 billion on their pets in 2019, up from $90.5 billion in 2018. That spend seems likely to reach $99.0 billion in 2020.
U.S. pet medication sales are forecast to surpass $12 billion by 2022, up from just $9 billion in 2018. Sales were already moving online, but the coronavirus pandemic has sped up the shift from veterinary offices and mail-in orders.
PetMed’s latest quarterly results reflect this trend. In the three months ended March 31, 2020, revenue increased 15.1%, to $74.3 million from $64.6 million a year earlier. Earnings rose 5.8%, to $7.0 million, or $0.35 a share, from $6.6 million, or $0.32.
Thanks to higher online sales because of COVID-19, the company acquired 107,000 new customers in the latest quarter. That’s compared to 101,000 new customers in the same period a year ago. The average order size for the latest three months rose to $90 from $85.
Growth in the online prescription market would likely have been even higher, except for the requirement that a customer first visit a veterinarian to obtain a prescription. As veterinary offices closed by COVID-19 re-open, PetMed can expect a further surge in new customers and sales. These gains should remain even after a return to normal.
There are a couple of other factors that should boost PetMed’s profit margins:
First, new minimum prices for drugs imposed by manufacturers should help firm up profit margins. All online retailers now face penalties and could lose their contracts with manufacturers if they price products cheaper than the agreed rate.
Second, the company has stopped TV advertising in the near term and is instead focused on online advertising and its expanding loyalty program. Typically, television is PetMed’s most expensive type of advertising. Switching from TV to online marketing could raise profit margins. Meanwhile, the company’s loyalty program should help spur reorders over time.
PetMed has no long-term debt and holds cash of $103.8 million. It also increased its quarterly dividend by 3.7% with the May 2020 payment, to $0.28 from $0.27. The stock now yields 3.5%.
Recommendation in Pat’sInner Circle: PetMed Express is a buy.
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