PetSmart Stock Price Diverges From Fundamentals

PetSmart Inc. (NASDAQ: PETM) may be trading more on outside forces than it is off of fundamentals. That is the take of Bank of America Merrill Lynch at any rate, and the move is after the stock jumped on outside pressure and after Barron’s defended the stock. Another call of caution was seen from Credit Suisse on Monday as well.

Investors should recall here that retail is currently looking weak, and the company lowered expectations before its activist-led stock rally came about. This creates a conundrum, where the stock is trading at a higher price than the intrinsic value might indicate on a standalone story.

Back on July 8, Merrill Lynch dropped PetSmart from coverage. The report was after Jana Partners took a 9.9% stake, with the firm, calling for a potential sale of the company. At the time, Merrill Lynch’s team covering the company said that it believed that a PetSmart combination with Petco or another high service independent firm would be possible.

The Alpha Generation team at Merrill Lynch has now removed PetSmart from the Top 10 Quarterly List of new ideas as well. The Merrill Lynch team said:

We are removing PetSmart from our Top 10 Quarterly list of US ideas due to a change in rating. Denise Chai changed her rating to No Rating, reflecting her opinion that the stock is no longer trading on fundamentals. We will not replace PetSmart with a substitute idea.

Credit Suisse also hosted a call to discuss the potentiality of a merger with Petco. Credit Suisse had a Neutral rating and $65 price target. The firm’s pre-call notes said:

Based on our analysis, 82% of PetSmart’s stores overlap with a Petco within 20 miles, 75% overlap within 10 miles, and 61% overlap within 5 miles. For reference, 19% overlap within 1 mile. That overlap is high and is likely to result in further investigation in any merger situation, but may not necessarily prevent approval. By comparison, in the office supply situation, 65% of OfficeMax stores overlapped with an Office Depot within 5 miles, slightly higher than the PetSmart/Petco overlap… we estimate that more than 51% of the specialty industry’s store growth over the last two years has been driven by non- PetSmart/Petco specialty retailers as they have accelerated store growth. That is a major reversal in trend, as prior to 2011, the two leading national chains had accounted for a majority of the growth, particularly post-downturn.

With shares at $70.30, their 52-week range is $55.00 to $77.32. PetSmart has a market cap of just under $7 billion, but note that analysts have a consensus price target of only $60.50 or so on the stock. PetSmart shares fell from $65 to just under $56 in May, and the stock had gradually recovered to $60 before the Jana stake was disclosed — sending the stock closer to $70 over the past couple of weeks.

Rival retailer Petco was acquired for some $1.8 billion back in 2006 in a private equity deal with affiliates of Leonard Green & Partners and Texas Pacific Group.

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