PetSmart’s businesses

Shares in PetSmart (PETM) surged last week after activist investor JANA Partners disclosed a 9.9% stake. JANA said it intends to discuss a review of strategic alternatives including exploring a sale of the company. In this part of the series, we’ll discuss PetSmart’s main businesses.

Based on 2013 net sales of $6.9 billion, PetSmart is North America’s leading specialty provider of products, services, and solutions for the lifetime needs of pets. The company is also a part of the Consumer Discretionary Select Sector SPDR ETF (XLY).

Merchandise represents the majority of total sales

According to its latest quarterly report, the company operated 1,340 stores, which sells high-quality pet supplies at everyday low prices. PetSmart offers approximately 11,000 distinct items in its stores, and 7,000 additional items on its e-commerce website— www.petsmart.com. The store carries nationally recognized brand names, as well as an extensive selection of proprietary brands across a range of product categories. Its merchandise sales, which comprises consumables, hard goods, and small pets, represented approximately 88.3% of total net sales in 2013.

PetSmart’s stores are usually located at sites co-anchored by strong destination mass merchandisers and are in or near major regional shopping centers. The company said it has an ongoing expansion program, opening new stores in both new and existing markets, and relocating existing stores.

PetSmart said the sales of its exclusive and proprietary products and services accounted for around 36% of the total sales in 1Q14. During the quarter, the company drove the increased penetration of these products to 27.5% of merchandise sales—a 250 basis point improvement as compared to 1Q13. It said it intends to drive double-digit proprietary and exclusive product sales growth over the next three to five years, and believes this “helps drive customer loyalty, and is a key to delivering continued merchandising innovation and differentiation.”

Services demand driven by grooming and boarding

In addition to products, the company also provides a wide selection of services, including professional grooming and boarding. Its PetsHotels provide boarding for dogs and cats, which includes 24-hour supervision by trained caregivers, as well as a day camp for dogs. As of May 4, 2014, the company operated 200 PetsHotels. The services segment represented 11.1% of its total net sales in 2013.

PetSmart noted in its annual filing that “services are an integral part of our strategy, and we are focused on driving profitable growth in our services business. We believe services further differentiate us from our competitors, drive traffic and repeat visits to our stores, increase transaction size, provide cross-selling opportunities, and allow us to forge strong relationships and build loyalty with our customers.”

Services sales increased 4.5% to $200.2 million for 1Q14 primarily due to continued strong demand for PetSmart’s grooming and boarding services, and the addition of new stores and PetsHotels since May 5, 2013.

PetSmart also provides full-service veterinary care available through strategic relationships with certain third-party operators. As of May 4, 2014, PetSmart had full-service veterinary hospitals in 853 of its stores. It owns 21% in MMI Holdings, which through a wholly owned subsidiary, Medical Management International—collectively known as Banfield—operates 846 of these veterinary hospitals. The remaining seven hospitals are operated by other third parties in Canada.

Increasing pet spending trends to benefit PetSmart and its peers

According to the American Pet Products Association (or APPA), pet spending in the U.S. is estimated to reach $58.5 billion—a 4.9% increase over 2013. APPA said in a statement that pet services showed the largest percentage of growth in 2013 and is poised to grow further this year. Veterinary care demonstrated significant growth in 2013, with $14.37 billion in spending, second only to food category spending. Pet insurance is also an upcoming category and is projected to grow to over $870 million by next year. Besides PetSmart, other companies in the space that will benefit from rising pet spending trends include privately held PETCO Animal Supplies, pet pharmacy PetMeds Express (PETS), lawn and pet-supply firm Central Garden & Pet Company (CENT) animal health products distributor MWI Veterinary Supply (MWIV), food and animal safety specialist Neogen (or NEOG), and pet health care service provider VCA Antech (WOOF).