The late 1980's and early 90's brought about the birth of the consumer internet. Still written off by many companies as a novel invention, a secondary market, the internet was not a major concern. Since the mid 1990's, with more and more people becoming connected to the internet, the potential for companies to reach consumers right in their homes began to be realized. Since then the internet has brought about a great change in the way business is conducted. Companies began allocating resources to internet development initiatives. The World Wide Web brought companies and investors together into a rapidly evolving market.
The .com bubble that emerged from 1997-2000 followed subsequently by a bust immediately thereafter left many internet startup companies of the time underfunded. The pet products industry gave us one of the most notable failures of the .com bubble, Pets.com. Initially well-funded, with an advertising budget that bought super bowl ads, the company failed due to a poor distribution model.
Though overshadowed by Pets.com, another pet related company emerged through the internet bubble and over the last 15 years, has impacted the distribution model of the Pet Pharmaceuticals and OTC industry. This paper will explore the economic and financial impact of Pet Meds Express Inc on the Veterinarian and Pet Pharmaceuticals market and analyze the path the company followed to become the largest online Pet Pharmacy in the world.
The Evolving Pet Meds Industry
In January of 2012, Dr. Doug Mader, former president of the North American Veterinary Conference moderated a heated debate between PetMeds Express and the Veterinarian community. This debate was due to the way PetMeds express generated revenue, by changing the distribution chain in the Veterinarian Pharmacy industry. Until PetMeds Express started an online pet pharmacy, Veterinarians held a sort of monopoly on distribution of pet meds. But how does a relatively small company in the Pharmaceutical industry make this kind of impact? PetMeds Express understood the potential of the internet early and creating a new market.
To better understand the effect that PetMeds Express is having on the pet pharmaceuticals industry, it is important to first understand the industry that they operate within. Zoetis, Pfizer pharmaceuticals animal health medications offshoot, estimates that the growing global food demand in emerging markets for animal proteins and the increased standard of living in emerging markets have helped the animal medicines and vaccines market grow to the currently estimated $22Billion market. Within this global market, PetMeds Express participates in a $4Billion dollar U.S. industry, according to their estimates. Multiple pharmaceutical manufacturers develop and sell pet pharmaceutical products, they sell directly to Veterinarians.
Within a $4Billion market, the internet has allowed a new company to come in and change the distribution system, even without the support of the manufacturing companies. Though PetMeds Express makes up only 6% of the US Animal Pharmaceuticals market, the company brought to light the potential within this market niche attracting competitors and the attention of bib box retailers, something that could cause further thinning of revenues and margins if PetMeds Express cannot align with manufacturers in the near future.
Animal Pharmaceutical Distribution in the US
Since the major pharmaceutical companies have refused to work directly with PetMeds Express to date PetMeds Express needed to navigate the supply chain in a creative way. Instead of buying from, manufacturers directly, PetMeds express has been forced to buy from a 'gray market' of distributors, assumed to be Veterinarians that order in large quantities to supply the company, though PetMeds Express representatives have not confirmed their supply sources.
Individual Veterinarian practices that dominate this market have voiced concern that the growing internet and retail 'big box' approach is eating away at one of their profit centers. Prior to this competition, Veterinarians' enjoyed a relatively non-competitive market. Animal owners would visit a Veterinarian, and due to convenience, would purchase medication directly from the Vet. This practice started to be threatened with the emergence of the PetMeds Express model, though Veterinarians still enjoy the major market share of around 67% according to PetMeds Express investor data. We must keep in mind that this figure represents individual Veterinarians and group practices together. These practices do not share in the same economies of scale as PetMeds Express, nor do they individually represent major competitors.
It is interesting to note that Dr. Foster and Smith Inc, a major competitor of PetMeds Express Inc, was founded in 2003. The Dr. Foster & Smith brand was also an early entrant to the internet market. Though the company is stock was up to an estimated $250 Million6 in 2008 and has since been estimated at around $170 Million. They are close in market cap to PetMeds Express with distribution via the internet as well, however, they are grouped in with the Veterinarians in the 67% market share. Assuming other variables are equal with this private company, they could make up a relatively similar +/-6% of the Veterinarian market, leaving around 60% of the current market to traditional Veterinarians.
Currently, PetMeds Express represents a small Cap stock with a market cap of $257,212,860 in 2012. Despite PetMeds Express' relatively small segment of the market, there is cause for worry among the Veterinarian community. In 2004, when the company went public, the industry was estimated to be at $3Billion and PetMeds reported revenue of $93,994 left the company with only 3% of the market at that time. Compare that with 6% of the $4Billion dollar current market and we see the trend of this online retailer's market segment growing. However, as with any business, past performance does not guarantee future profits.
PetMeds isn't the only threat to the Veterinarian retail pharmaceutical segment. The company's growth attracted competition and now the distribution includes The "veterinarians, online and traditional retailers." In fact, it is the retail segment that is beginning to lower margins for PetMeds Express and creates a problem the company must address and work to overcome
In efforts to continue maximizing shareholder value, retailers like Wal-Mart and Target also want a larger slice of the pet medication segment. Their large volume purchasing power makes them a great threat to both the Veterinarians and the new online retail segment in which PetMeds operates. In 2011 and 2012 PetMeds Express has started seeing the effects of a highly competitive market slow down growth, increase the cost of new customers and reduce profit margins.
Ethics and Risk in the Pet Medicine Industry
When PetMeds Express entered the market, they were depending on consumers that enjoyed the convenience of purchasing over the counter medications on the internet as well as those consumers whose veterinarians either did not carry various prescribed medicines. Veterinarians however, receive about 25% of their revenue from the sale of prescriptions that they write and fill. As the company evolved, so did PetMeds Express business model, which ended in some ethical problems that the company faced. As with all publicly traded companies, PetMeds express had to figure out how to increase profits but how could they increase sales of prescription medications and thus increase profits?
This problem initiated an innovative idea that would allow consumers to call up, consult with a Veterinarian over the phone and immediately receive a prescription, which was converted to an order and sent out to the customer. This was an excellent way for the online prescription drug retail business to grow. If customers could skip the Veterinarian visit all together, PetMeds Express could capitalize on more pet owners that valued convenience and generate another income stream through their Veterinarian consultations. However, this method of selling prescriptions without actually seeing the animal did not sit right with the rest Veterinary community. Already worried that the growing online company could eat into the Veterinarian's revenue stream from medication sales, PetMeds Express had crossed an ethical line that caught the attention of the Veterinarian community as well as regulators.
Only three years into operations in 1999, PetMeds Express was disciplined by the Florida Board of Pharmacy for the over the phone prescriptions. The company received a $30,000.00 fine, but more than this, they upset the Veterinarian community. Though the company immediately complied, this former practice continues to come up, even at the 2012 North American Veterinary Conference (NAVC).
At the 2012 NAVC, a petition by Birmingham, AL Veterinarian, Dr. Doralee Donaldson, drew 149 signatures and ended up with PetMeds Express withdrawing as a sponsor of the event. Instead, representatives of PetMeds Express showed up to the NAVC and did a panel discussion, attempting to mend ill feelings from the Veterinarian community. Moving forward, PetMeds express intends to work with the Veterinary community, encouraging regular Vet visits and attempting to show Veterinarian's that there is room in the market for both interests.
PetMeds was the first non-veterinarian owned commercialized online pet pharmaceutical company and first public company in the space. When new competition in the online space along with the competition from the retail segment began, profits began to get sluggish. By reviewing data taken from the company's annual reports, we can see that PetMeds Express has experienced a decline in total revenues since 2010. Profit Margins stayed close to 10.5% in the years from 2008 to 2010, however 2011 and 2012 saw year over year declines, with a margin of just less than 7% for 2012.
By analyzing the online company from a different approach, we can see how the company is maximizing the potential of their people. According to Lowell L. Bryan of McKinsey Quarterly, an excellent measure an internet era company's performance is profit per employee. In addition to measuring returns on invested capital, this shows the contribution made by the team members. Bryan says that "from 1995 to 2005, the top 30 largest companies in the world (ranked by market capitalization) have seen their profit per employee rise to $83,000, from $35,000."
Using this methodology to analyze the annual profit to number of employees taken from PetMeds Express annual reports, we see they had their best year in 2010 with profit/employee of $114,546. The stock has suffered in the last couple years and so has the profit per employee; in 2012 the profit/employee was down to $80,478. Not bad for a small cap company.
The drop in profits is due to several factors, including the poor economy, which is causing pet owners to be more cost conscious, increased entrance into the market by other online retailers like Amazon.com, and an increase in competition from large retail chains like Wal-Mart, Target, Wal-Greens. This means that PetMeds Express must advertise more, and lower their prices to stay competitive, thereby lowering profit margins in the short term until other strategies, including additional advertising, help the company grow.
By examining the graph on the right, we can see how PetMeds Express has performed against the market. This graph shows how $100 invested in 2007 would perform if invested in PetMeds Express vs. the S&P 500, Russell 2000 and Nasdaq Composite Indexes. From 2008 to 2010, their stock experienced high growth and performed well against the market with the $100 investment at $187.09. However this changed in 2011 when the company experienced more competition and lower profit margin and pricing. If we look at the trend in 2009 PETS enjoyed a 48.5% gain, followed in 2010 by a 35% gain. In 2011 there was a 28.5% loss and a 21.9% loss in 2012 which puts the stock back on par with the other indexes, however still trending down.
PetMeds Express has grown quickly and carved out a niche internet based distribution system for pet OTC and prescription drugs. By looking at the company's solvency, liquidity and profitability, through ratio analysis we can see if there are some financial causes for concern outside of the slipping profits. We can get a better understanding of this by looking at the company's financial ratio's based on the last 4 quarters ending March 31, 2013
The company has a current ratio of 8.03 which is very high. This leaves the company in a good position if they need to acquire related competitors. This number is also due to the large amount of inventory the company, which can be seen by removing the inventory in the quick ratio of 5.81. The Net Working Capital is $59,162, so there is no immediate risk of the company running out of money.
Use of Assets:
The 12 month inventory turnover ratio is at 5.83. If we compare this to the largest Pet retail store, PetsMart, their 2012 inventory turnover ratio was at 7. If compared with a human pharmacy, the industry standard is 12. Even though PetMeds Express is below this, they also have higher overhead and a larger inventory holding expense. This lower ratio could also due to inefficiencies in the gray market system PetMeds Express must purchase through.
The return on assets ratio is.19 while the return on equity ratio is.21, so even though the company's profit margin for 2012 was.07, they are still doing well for their shareholders. On top of this, the profit margin increased to from.07 to.09 during the first quarter of 2013, perhaps an indicator that the company is finding ways to lower their costs, or that the increase in marketing in response to more competition is beginning to work. By continuing to watch this number, we will get an idea of the potential for PetMeds Express to remain competitive.
The total debt ratio of.11 and the debt to equity ratio of.12 shows that PetMeds Express may not be fully utilizing their leverage. Since they have hit a couple of rough years of declining profits, they should consider investing in other companies that could strengthen their position.
PetMeds Express has also experienced year over year drop in EPS in 2011 and 2012. EPS was 1.14 in 2009 and began to decline to.92 in 2011 and.78 in 2012. The PE Ratio in 2012 was 14 and is currently listed at 15.14 Based on this the price investors are willing to pay would be about 18 for 2012.
Using the 2012 PE ratio and analyzing some of PetMeds current market competitors in the pet and pharmacy business, we get an average P/E ratio of 19.5. Using this number we can multiply the industry average with PetMeds EPS of.82 leaving us with about $16 per share intrinsic value. It seems Pet Meds stock could be slightly undervalued currently.
PetMeds Express must do something to close the gap between their current and previous performance. The additional advertising the company started in the last 2 years has started helping them rebound. What are some other options the company may have?
Since PetMeds Express depends on the gray market for distribution, they have a high level of risk if large box stores leverage their purchasing power and connections to gain an advantage. PetMeds Express could manage to negotiate wholesale agreements directly from the pharmaceutical manufacturers, lowering their overhead. However this type of distribution would likely be available to their competitors as well if opened up.
The company is relatively financially healthy and facing a highly competitive market. Perhaps they could consider a partnership with the competition. An obvious partnership would be with one of the large retailers like PetsMart. Both Pet retailers face competition from Wal-Mart and other larger retailers. A partnership could open a new shared revenue stream for each company as well as potentially sharing their purchasing power. Though cannibalization of some other products couple play a role in the potential benefit of offering PetMeds pharmaceuticals at the popular and growing store front retailer. Though PetsMart has their own online retail, they do not carry pharmaceuticals. Perhaps the established brand of PetMeds Express would be able to handle the pharmaceuticals that these companies currently do not carry.
Perhaps looking to one of the leaders in the global pharmaceutical industry, like Pfizer, can give us some insight into the future potential of the market. Pfizer recently re-branded their Animal Health division into Zoetis, showing that Pfizer see's the potential in this segment enough to brand for it specifically. With some good business decisions focused on creating partnerships, especially with the pharmaceutical manufacturing companies, PetMeds Express can continue to define itself as the online force to be reckoned with in the animal medicine industry.
The company has made it through some rough beginnings including several legal battles. They pulled through the internet.com bubble and grew into the largest Animal Pharmacy with 6% of the market. After examining the company's financial ratios, it appears that the company is currently healthy. This is likely one of the reason's Zack's average brokerage rating for this stock is a hold.
After reviewing the company's history and current stock performance we get a picture of an innovative company that grew with technology, but now must continue to be agile and adapt to change as competition catches up. PetMeds Express has gained 6% market share within the US Pet Pharmaceuticals industry since the company started in 1996. This growth attracted competition to the distribution chain. These competitors include other online retailers and large national discount retailers that are forcing prices lower and decreasing profit margins. In total, Since PetMeds Express was a pioneer in the nationalized pet pharmacy model during a fast moving internet era, they have been a major influence in Veterinarian's losing 33% of this market and changing the distribution model within the industry in 17 years.
In the future, as countries become more developed, eat more proteins and own more pets, the need for animal pharmaceuticals will also grow. If PetMeds Express can find a way to exploit the growing global pharmaceutical market, they will open up a new world of revenue and profit.