(PETS) PetMed Still Underperforms

Recently, we reaffirmed our Underperform recommendation on PetMed Express (PETS) with a target price of $11.00.

PetMed has been reporting disappointing results over the past few quarters. Lower revenues coupled with higher operating expenses had a negative impact on margins. Moreover, the company also witnessed decline in new customers to 130,000 in the last reported quarter, down from 134,000 in the year-ago period.

The average order size has declined by $4 compared to the year-ago quarter to $78 amidst economic uncertainty that forced customers to become price sensitive. PetMed also witnessed a 5% decline in new reorder sales to $9.4 million primarily due to an increase in customer acquisition costs. This is a big blow for the company as it depends on advertising for expanding its customer base.

Despite general and administrative expenses remaining almost unchanged at $5.1 million during the quarter, a 13.2% increase in advertising expenses led to a 6.8% rise in operating expenses (excluding   depreciation and amortization) to $10.7 million.

Consequently, operating margin declined to 13.3% from 20% in the year-ago period. Moreover, the cost to win a customer increased to $42 compared to $36 in the year-ago period due to reduction in response rates based on increased competition, softer demand and higher advertising costs. The company expects the cost to acquire a customer to be around $40s for the next couple of quarters. Consequently, we expect the decline in margins to persist in the forthcoming period.

PetMedoperates in a highly competitive and fragmented pet medications market. The competitors include veterinarians, traditional retailers, other mail-order and online retailers of pet medications and other health products.

The company has witnessed higher pricing pressure in over-the-counter market due to increased competition. To address increase in competition in Flea and Tick segment, PetMed is planning to adopt a more aggressive pricing strategy that might hurt the company’s margins further.

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