Petco Stock May Have Been Dumped Too Early, but Know the Risks

Has the social media crowd prematurely exited the recent public market debut of Petco Health and Wellness Company (NASDAQ:WOOF)? Looking at the price action for WOOF stock, it’s hard not to disagree with the thesis.

The front of a Petco (WOOF) store in Los Angeles, California.
Source: Walter Cicchetti / Shutterstock.com

According to a mid-June article from MarketWatch.com, social media traders quickly rotated out of Petco Health and Wellness and into another popular community-driven trade.

This put a hurting on WOOF stock, which is down more than 20% since its first closing price.

If you’ve taken a look at the various posts on social media networks, you can see that many of the meme traders are not operating with a full deck. That’s not to imply that everyone acts like this, but if you’re intellectually honest, the directive catalyzing the movement is a bizarre one.

This time around, it’s possible that meme traders were too impatient in abandoning ship on WOOF stock. Fundamentally, Petco is tied to one of the most reliable investment narratives available: millennials’ love for pet ownership.

Forget electric vehicles. Ovrs.com argues that pets are the future.

Further, it’s not just opinion pieces that are driving this narrative. According to revenue data from the American Pet Products Association, the total pet-care industry generated revenue of $103.6 billion in the pandemic-disrupted year of 2020.

That’s up nearly 7% from 2019’s tally, which is remarkable considering the context.

On paper, you have two strong tailwinds that you can’t ignore when assessing WOOF stock.

First, the millennial population — which by the way represents the largest workforce in the U.S. — continues to prioritize their four-legged family members.

Second, industry data seemingly confirms that come heck or high water, pet owners of any demographic will support their pets.

So, social media got this wrong, right?

A Potential Headwind in the Shadows for WOOF Stock

When you consider the revenue performance of Petco, it’s also difficult not to feel good about WOOF stock based on the underlying industry optimism.

From the company’s S-1 filing with the Securities and Exchange Commission, Petco reported net sales of $1.41 billion in the 13 weeks ended May 1. That’s up 27% against the year-ago period.

Further, from annual data on Gurufocus.com, Petco rang up top-line sales of $4.92 billion in the year ended Jan. 31, 2021. This represented an increase of nearly 11% year-over-year.

Again, we’re talking about an encouraging backdrop for WOOF stock: people will support their furry friends through difficulties thick and thin.

But as I explained for my writeup regarding Zomedica (NYSEAMERICAN:ZOM), the demand profile for pet care isn’t balanced.

In the APPA data, the association breaks down pet-related revenues into four categories: pet food and treats, supplies, live animals and over-the-counter medicines, vet care and product sales, and other services.

According to expert forecasts for the end of 2021 sales, the vet care and product sales is projected to increase at the lowest growth rate at 2.9%.

Initially, that doesn’t sound like much of a problem. If you look at Petco’s Form 10-Q, the company’s services and other business unit generates the smallest amount of revenue (only 11.4% of total revenue during the 13 weeks ended May 1, 2021).

However, before you jump aboard WOOF stock, you should note that the services unit enjoys the greatest growth rate by far (compared to dog and cat food, and supplies and companion animals).

Moreover, Petco isn’t profitable on a net income basis. Therefore, any impact to the services unit could turn off investors, who want to see something positive following a rough introduction.

Thus, social media may be onto something.

A Risky but Possibly Worthwhile Bet

For me, WOOF stock is a play on the economy. If the recovery were to pan out without issue, then Petco is a great discount at this price. But if it were to go sour, you should be aware that the risks are higher than you might think.

According to npr.org, many households abandoned their pets during the Great Recession, drawing sharp criticism from pet advocacy groups.

I don’t believe for a second that this time would be different if we encounter another economic crisis. In that situation, I wouldn’t want to touch WOOF stock.

Without having that crystal ball, I would say this. If you want to take a shot, put a modest amount of your risk portfolio to work with WOOF stock. But do keep that powder dry because it’s not inconceivable that another discount is on the way.

On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.


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