Streetwise

Lauren Rudd

Sunday, June 27, 2010

Wall Street - Frustrating but Profitable

Wall Street can be a frustrating place, especially when the intrinsic value of a company’s shares goes unnoticed. Unfortunately there will be times, actually many times, when regardless of how well a company has performed in the past and how upbeat its future looks going forward, it is still ignored.

So what do you do in such an instance? Relax, because the only cure is time. If a company is a true performer, and if the earnings are there quarter after quarter and year after year, then it is only a matter of time until the shares come into their own. The good news is that the reward is often well worth the wait.

An excellent example of a company with a reasonable intrinsic value that continues to do well, despite the current economic environment and being ignored a year ago, is PetSmart (PETM). As a matter of complete disclosure, this company is a particular favorite of mine for reasons other than just investment returns, given an indubitable collection of three dogs, seven cats and two horses, up from a count of three dogs, two cats and one horse when I last wrote about PetSmart.

More importantly, a year ago my forecast for earnings was $1.52 per share with a 12-month price target on the shares of $24, as compared to a price back then of $20.80. In addition, there was an indicated annual dividend yield of 2.00 percent. This is one selection that I have to give myself a bit of pat on the back for as the shares recently closed at $31.55, while the company earned $1.59 per share for FY 2010.

Going forward, PetSmart recently reported first quarter earnings of $0.46 per share, up 24 percent when compared to $0.37 per share in the first quarter of 2009, while net income came in at $55.6 million, as compared to $46.3 million in the first quarter of 2009. Sales during the first quarter increased 5.1 percent to $1.4 billion, while comparable store sales were up 2.8 percent.

Also during the first quarter, the Company generated $86 million in operating cash flow, spent $31 million in capital expenditures, distributed $12 million in dividends, and repurchased $107 million of PetSmart stock. The Company ended the quarter with $288 million in cash, cash equivalents and restricted cash and zero borrowings on its credit facility.

Looking ahead, the company raised its comparable sales expectations to low- to mid-single digits and increased its earnings guidance to between $1.82 and $1.92 per share.

PetSmart also recently announced that its board had approved a 25 percent increase in the quarterly dividend to 12.5 cents, along with a new $400 million share repurchase program.

Since 1994, PetSmart Charities, an independent 501(c3) non-profit animal welfare organization is the largest financial supporter of animal welfare efforts in North America, having provided more than $109 million in grants and programs benefiting animal welfare organizations. Through its in-store pet adoption partnership with PetSmart Charities, PetSmart has helped save the lives of more than 4 million pets.

The bottom line is that PetSmart continues to perform well, despite the recession, and is generating significant free cash flow. Furthermore, the stability and predictability of the company’s cash flow demonstrates its continued business strength. It is also a testament to the importance of pets to their owners, with many pet owners often cutting back on personal expenses to ensure their pets are well cared for.

Meanwhile, PetSmart shares appear undervalued and remain an excellent candidate for additional research. The intrinsic value, using a discounted earnings approach with an earnings growth rate of 8 percent and a 10 percent discount rate, is $56 per share. The more conservative free cash flow to the firm model produces an intrinsic value of $38 per share.