Jim Cramer on PETS and PETM; PETS Shorts Probably Betting On Patent Expirations -- We'll See....

We mentioned the other day that Jim Cramer pitched PetMed Express (PETS) on his CNBC show. We don't always watch Mr. Cramer (or CNBC), yet we share the video below because we've previously discussed PetMed Express and are currently long the stock. Plus, Mr. Cramer succinctly details the PETS "story" as well as the merits of Petsmart, Inc. (PETM), another company we've long admired but in which we have no position.

Following a sharp run on higher volume over the past week, PetMed Express "gave some back" yesterday and again on a broker downgrade today. Piper Jaffray made a "valuation call":

• 'Piper analyst says, "We are downgrading shares of PETS to Neutral this morning based strictly on valuation, as the stock has surged through our $21 price target this week and is up over 14% since the beginning of March.' Please see this link for more details.
  

Back to the sharp "run" -- we think at least some shorts are covering, helping fuel the stock's recent surge. Short interest is at a 12 month high:
We're surprised by the increasing short position given PetMed's favorable fundamentals and margin/growth profile. However, we think "shorts" are likely betting on certain patent expirations related to key PetMed products that might become available as generic offerings at other online/offline stores sometime this year. We're less certain of the impact from potential changes in brand name and generic offerings, but -- in general -- have observed lower prices on similar products offered by Amazon.com (AMZN).

PetMed's valuation is now in our fair value range and, as in the past, we need to maintain valuation discipline. Still, for now, we're inclined to maintain our current exposure unless the valuation moves above our range and/or enters egregious territory, à la Amazon or Blue Nile (NILE), both of which are trading at approximately 65 times trailing earnings versus PetMed Express at 19 times. Put simply, if PETS garnered the same valuation, shares would be at $65 today. We note that PetMed Express has a higher margin profile than both companies, as well as a very healthy ROE/ROIC around 30% (including excess cash on balance sheet).

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long PETS.

© 2010 Jeffrey Walkenhorst
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