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PetCo Animal Supply (PETC)

Closing Price 30 1/2  as of October 7, 1997

Petco Animal Supplies is the #2 retailer of premium pet food and supplies behind PETsMART. The company's stores carry up to 10,000 pet-related items including premium cat and dog foods, collars, leashes, grooming products, toys, pet carriers, cat furniture, doghouses, vitamins, and treats. The company does not sell dogs and cats, instead working with humane societies to sponsor pet adoption and vaccination. But it does sell birds, fish, and reptiles and birdcages, aquariums, and supplies. It operates more than 400 stores across the country. Headquarters are in San Diego, CA.

Steve's Criteria #1 - Great company with management that has shown that they can sustain the growth of the company successfully.

There are tens of thousands of pet stores across the country. There are over 110 million cats and dogs in this country. Thus, there is a huge demand for pet supplies. PetCo and PETsMART are the two main companies undergoing a major effort to consolidate the pet supplies industry. Both have experienced very healthy growth over the past five years, and it is likely that both will succeed in growing over the next decade. As a company, PetCo has executed better than PETsMART the past two years, always meeting or beating quarterly estimates. PETsMART has stumbled quite a bit, missing estimates in the first and third quarters of 1997. PetCo's stock has been volatile, but it is still near an all-time high. On the other had, PETsMART has dropped from highs of nearly 30 to its current level of about 10.

PETsMART plummeted because their plans for hyperactive growth were affected by weaker than expected same-store sales. PETsMART is like Home Depot - gigantic, 25,000 square foot stores. Unfortunately, this super-store model hasn't been definitively proven to be the best model for pet supplies, because the super-space has to be filled with lower-margin, lower-revenue products. Super-size stores seem to work better for home-building supplies than for pet supplies.

PetCo stores are smaller than PETsMART stores (15,000 square feet and less).PetCo have planned for and experienced reasonable growth over the past few years.  They seem to have executed this plan well, as the rise in their stock indicates.

Steve's Criteria #2 - Expected earnings growth of 25% or more for the next five years

3 analysts issue a median 5-year growth rate of 30% per year. Earnings growth should be reasonably predictable, because building more and more pet stores and serving customers well is not rocket science.

Steve's Criteria #3 - Current stock price that allows for 25% or more year-to-year appreciation in the stock.

Using the Lai Fund SMEG-5 Analyzer, and assuming that PetCo will experience the predicted earnings growth, the stock should appreciate within the following range over the next five years:

Low Return: 15% annual growth

Middle Return: 25% annual growth

High Return: 33% annual growth


PetCo - 10/7/97

Price: 30 1/2

`97 earnings 1.12

`98 earnings 1.46

P/E ratio 27

Market Cap: about 600 million

Expected 5-yr annual growth rate: 30%

% LT Debt to Market Cap: 7%

Lai Fund SMEG-5 Return: 25%