Streetwise

Lauren Rudd

Sunday, June 19, 2011

Wall Street Can Be Frustrating

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 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.

An excellent example of a company with a reasonable intrinsic value that continues to do well, despite the current economic environment and is often ignored is PetSmart (PETM). This company is a particular favorite of mine for reasons other than just investment returns, given my indubitable collection of pets.

A year ago my forecast for fiscal 2011 earnings was $1.95 per share and $2.25 for 2012 with a 12-month target price on the shares of $36 for a potential capital gain back then of 14 percent. There was also an indicated dividend yield of 1.58 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 $43.27, while the company earned $2.01 per share for FY 2011. (A company’s fiscal year is usually referred to by the year in which the last fiscal month occurs.)

Going forward, PetSmart recently reported first quarter earnings of $0.61 per share, up 33 percent when compared to $0.46 per share in the first quarter of 2010. Net income totaled $71 million in the first quarter of 2011, compared to $56 million in the first quarter of 2010. Total sales for the first quarter of 2011 increased 6.8 percent to $1.5 billion.

Comparable store sales, or sales in stores open at least a year, grew 5.0 percent. Services sales, which are included in total sales, grew 9.0 percent to $167 million.

During the first quarter, the company generated $96 million in operating cash flow, spent $31 million in capital expenditures, distributed $14 million in dividends, and repurchased shares in the amount of $102 million. The Company ended the quarter with $290 million in cash, cash equivalents and restricted cash and zero borrowings on its credit facility.

The company’s guidance for the second quarter of 2011 is for sales growth in the mid-single digit range, and earnings per share of between $0.47 and $0.51. Guidance for all of 2011 calls for comparable store sales growth in the low- to mid-single digit range and total sales growth in the mid-single digit range. At the same time, PetSmart is raising its earnings per share guidance to between $2.32 and $2.42 per share.

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 $134 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 4.4 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 15.10 percent and a 15 percent discount rate, is $54.42 per share. The more conservative free cash flow to the firm model produces an intrinsic value of $71.63 per share. In both instances, the intrinsic value is considerably above the current $43.27 share price.