Thursday, October 30, 2008
(Cont'd from above)...

At Wal-Mart's annual analyst meeting this past Monday, the head of their grocery division said, "As part of our focus on growth, we've spent a lot of time on pets... Customer feedback on the light remodeling Wal-Mart's done for pets in concept stores received a positive response, with customers saying Wal-Mart understood their passion for pets in a nation that loves its cats and dogs as much as it loves its children."

That's very good news for Wal-Mart, which is becoming more of a pet care provider, rather than just a pet food merchant.

Wal-Mart is improving merchandising of pet food. A report we got from Palley Research said that they're quietly testing a grooming service too. Now, we've now made that quiet testing into a noisy reality...

Wal-Mart said it expects share gains in the year ahead, thanks to lower prices. In other words, they're going to eat PetSmart's lunch... We know this, because it's happened before...

Here's the litany...

Everytime Wal-Mart focuses on a particular department to improve merchandising or remodel in order to drive traffic, it causes enormous disruption for its competitors. If Wal-Mart decides to put more effort into selling what YOU sell, two things tend to happen... your gross margins deteriorate, because you have to lower your gross margins to try to compete... you know, basically, they're selling the stuff that you sell at the price that you have to buy it from the manufacturer. It is that different. And it's very hard to compete on price, when that's... it's impossible. But you still have to try, or you will crushed.

The second thing that happens... people stop going to your stores. That's also bad.

So the last thing you want to be is a retailer that's in Wal-Mart's crosshairs. They did it to Whole Foods Market Inc. (WFMI), in 2006, when they rolled out organic choices in fresh produce, dairy and dry foods... more than doubling their organic offerings. Whole Foods has had troubles on its own, but the stock slide... it hasn't seen $70 since December of 2005... I think, coincided with Wal-Mart's invasion of its turf...

Also, I have not used my hilarious, "teach a man to fish, he'll eat for a day... teach him to shop at Whole Foods, and he'll eat for the rest of his life, or until he goes broke" line in a while. Teach a man to shop for fish at Wal-Mart, and he can buy one and get one (free)...

Then, in the spring of 2007, Wal-Mart decided to make a bigger push into electronics, by remodeling departments, improving their offerings with better flat-screen TVs, MP3 players, and computers... Both Best Buy (BBY) - best of breed - and Circuit City Stores Inc. (CC) - worst of breed - took hits to their gross margins and same-store sales. At Circuit City, you now need like a microscope to see where that stock is...

In May of this year, Wal-Mart launched phase three of its generic prescription drug program. Phase one launched in September of 2006. Since then, Wal-Mart has gained an average of 30 basis points (i.e., 0.3%) in all of its markets, killing the other drug stores, man... In the markets where it gained share, the gains were about 70 basis points on average. I mean, that's a huge take... In those same markets, grocers lost an average of 110 basis points (i.e., 1.1%) on average, so anybody who's in Wal-Mart's crosshairs gets killed.

You know who Wal-Mart is really like?... It's like the Red Army... it's huge. Any individual aspect isn't high quality, but it just rolls over the competition... Like the Red Army, it's willing to sacrifice anything, including gross margins... because Wal-Mart can crush any category with its scale and skill...

So it doesn't take a genius to figure out what's going to happen to PetSmart...

Now, the company's the price leader for many of its products. You know that, with Wal-Mart gunning for it, many of those prices will have to come down. PetSmart has over 1,100 stores, 13% of the total pet supply market share, and 12% of total pet services. Now Wal-Mart has 3,600 stores, and has just one degree of separation from its low-cost overseas suppliers... which is what allows its home category offerings to be 15-50% cheaper than their competitors'... PetSmart has six touches between it and its suppliers. Every touch eats into their margins.

What I'm saying to you is that Wal-Mart can bring it to you much cheaper...

Now they have to worry about Wal-Mart...

Consumers don't stop feeding pets when times get tough. They trade down... Maybe they eat some cat food themselves...

In September, sales of private-label cat food sales grew 13.6%, and sales of private-label pet supplies grew 17.8%. We know people are already heading into Wal-Mart in droves to buy groceries on the cheap.

I think cheaper pet care will be next...

Good news for Wal-Mart might as well be the apocalypse for PetSmart...

[updated as verbatim recap]

Here's the bottom line...

The bottom line!:     A pet-friendly Wal-Mart (WMT*) means it's time to sell Petsmart Inc. (PETM)...  When Wal-Mart decides to compete with a company, the competitor gets smoked.  PETM is next and, believe me, you don't want to be in a stock while Wal-Mart  forces it to cut prices and steals its customers.

Read Jim's next Segment here