The Squeeze is on for Petco Stock, Buy it When the Dust Settles

Key Points

• A short squeeze in Petco Health and Wellness signals a reversal in the market. 
• The new CEO is a capable retail industry veteran who can grow this business. 
• Investors can expect to see results begin to improve as soon as fiscal Q3 results are release for this year. 

Petco Health and Wellness NASDAQ: WOOF stock price struggles are over. The steep 90% decline from peak to trough is over, and a bottom is in place, with a full technical reversal soon to follow. The reversal in price action will follow because of the company's bold move to hire Joel D. Anderson as CEO. 

Joel D. Anderson has over 30 years of experience in the retail industry, having served as CEO of Walmart and then Five Below. During his tenure, he grew Five Below’s store count by 300%, leveraging the growth and margin with eCommerce. Revenue grew by 600%, with earnings regularly outpacing consensus estimates and sustaining a high double-digit pace. The assumption is that he will take Petco and invigorate its business with his experience. 

The pet market is a solid, stable market growing at a low-single-digit pace in 2024. The pace of growth is expected to accelerate in 2025 and rise to the mid-to-low single-digit range by 2016. Pet spending, driven by consumables, services, and products, is expected to sustain that CAGR through the decade's end. 

Pet industry growth is driven by increasing pet ownership compounded by higher per-capita spending, which sustains healthy cash flow for the industry. Industry leader Chewy (NYSE: CHWY) is growing at a low-single-digit rate in 2024 and widening margins. Its margin expansion was significant, increasing adjusted earnings by nearly 50% and providing cash flow sufficient to repurchase shares. 

Petco Has Rough Quarter, but Outlook Brightens With Proven CEO

Petco had a rough quarter in Q2, with little to truly be said that is good about it. The company’s store closures, diminished footprint, and mix cut into results, leaving revenue down by 0.5% despite industry-wide growth. Segmentally, Supplies and Companion Animal is the weak spot, down 4.7% compared to last year and offset by growth in Consumables and Services. The worst news is that the margin contracted considerably from the previous year, leaving the GAAP net loss nearly double, adjusted EBITDA down, operating cash flow down 28%, and free cash flow down. 

The good news is that free cash flow is down but comparably strong, with a decline of only 5.5% and helps sustain financial health. Balance sheet highlights include steady cash, inventories and total assets offset by steady liability and debt. Leverage ratios are low, with long-term debt at 1.3X equity and 0.3X assets, so no red flags are present. With the new CEO on board and the balance sheet strong, investors might expect some aggressive moves over the next few quarters. 

Beware of Short-Squeeze Meme Mania

The price action in Petco stock was sparked by the Q2 release and outlook but is driven by the short-sellers. Short interest in the stock was nearly 30% at the end of the month and is likely much lower now. Roaring Kitty threw gas on the fire with a post on Reddit asking who was on board for the squeeze so it could continue for days. The volume is spiking along with the price movement, so it is significant regardless of the cause.

Because short-selling is a factor, investors should expect market volatility until there is a clear sign of business improvement. That is likely in November when the subsequent earnings report will be released. 

The price action in WOOF rose 63% in a matter of days and will likely move higher over time. However, resistance targets near $5.50 will likely cap gains soon and produce sideways action over the next few months. Price pullbacks could move as deep as $3.90, $3.25, or $2.65, presenting attractive entry points for speculative positions. The long-term play is for a full reversal that will only be considered seriously once the short sellers are out of the market. The technical signal for that will be a reversal pattern confirmed by a price break out.