Is the Third Time a Charm for Petco (NASDAQ: WOOF)?

Petco NASDAQ: WOOF IPO’d last week. If you feel like you’ve heard that before, you’re right… And you’ve also been investing for much longer than the average Robinhood user. Petco first IPO’d in 1994, before being taken private in 2000. It went public again in 2002, but was taken private again just four years later, in 2006.

The company, which offers pet products through brick-and-mortar stores and online platforms, is going public at a time when the pet industry is booming; according to the American Pet Products Association, US pet expenditures have not seen a single yoy decline in at least the last 25 years.

But with opportunity comes competition. Chewy NYSE: CHWY is dominating pet e-commerce, with last quarter’s 44% yoy increase in revenue qualifying as a disappointment. Freshpet NASDAQ: FRPT is building an economic moat by placing its refrigerators in mainstream retailers’ stores. Freshpet expects its 2020 full-year revenue to grow by nearly 30% yoy.

How Does Petco Measure Up?

Petco’s net sales were up 9% yoy to $3.58 billion for the 39 weeks ending on October 31, 2020. That growth rate is sluggish compared to Chewy and Freshpet, but if you annualize that amount, Petco is trading at 1.7x sales. Chewy is trading at 6.6x sales and Freshpet is trading at 19x sales.

The problem, however, is on the bottom line. Petco reported $24.8 million in net losses for the 39 weeks ending on October 31. That is a lot better than the $94 million in losses for the same period a year ago, but a problem nevertheless. Losses are okay for high-flying growth stocks that have a path to profitability, but not for a company like Petco, that has been around for 55 years.

Moreover, Petco had around $3.3 billion of debt as of October 31. Low interest rates make it easier for Petco to service its debt, but the company is going to struggle to pay it down unless it can turn things around.

Can Petco Start Generating High Profits?

Petco, with nearly 1,500 stores, has a sizeable brick-and-mortar footprint. But that is not something to brag about in 2021. Petco is likely going to need to downsize at some point and close its unprofitable locations.

At the same time, Petco needs to increase its online sales. Petco’s CEO Ron Coughlin assured investors that he is investing heavily in digital options. Same-day delivery now makes up 30% of Petco’s e-commerce orders, which shows that the company has a solid digital infrastructure.

Petco has name recognition and exclusive products – 70% of Petco’s products are exclusive to its stores.

But the aforementioned Chewy is formidable competition for Petco in the e-commerce space, and it’s not the only one; AmazonNASDAQ: AMZN and Walmart NYSE: WMT are also making big pushes into online pet retail. Those companies have name recognition of their own – and the resources to take a lot of market share.

Petco faces several headwinds, but if the company closes its unprofitable stores and builds an e-commerce operation that gives pet owners convenience at a reasonable price, it can carve out a nice piece of the (big) pet industry pie.

How Should You Play Petco?

Petco’s owners were originally targeting a $14-17 a share IPO price, but ultimately settled on $18 a share. The market had no issue with that price. In fact, it may have been a little low, as shares raced out to above $30. At the moment, shares are changing hands at $27.24 a pop.

That Petco, a company with warts, can generate such high demand for its IPO, shows that the market is frothy. While you can talk yourself into a company like Snowflake NYSE: SNOW, which IPO’d in November, at a high price, Petco’s viability as an investment is very price-dependent.

At the lower end of the original IPO target range, Petco is a solid risk-reward. But in the high $20s, Petco doesn’t make a lot of sense. IPO’s, however, can be very volatile in their first few months on the market. If Petco pulls back too much, consider pouncing.