For the second week in a row, I am following Doug Kass into a trade. To be fair, this name was already on my radar before Dougie gave it a positive mention on the Daily Diary this week. The name of the company is Petco Health and Wellness Company, Inc. and has one of most memorable ticker symbols -- (WOOF) -- in the market, at least for us dog owners.
This company is based in San Diego and the firm provides a variety of services to pet owners such as veterinary care, grooming, training, pet health insurance services, as well as veterinary services through its Vetco mobile clinics. Petco also markets pet consumables, supplies, and services through petco.com and several other websites.
While I remain concerned about retail spending, given the average consumer has lost ground to inflation for 23 straight months, demand for pet services is more inelastic than some other retail categories. There are some 70 million pet owners in America, and this is an approximately $100 billion market. That said, the stock has been more than cut in half over the past year as the company faces headwinds in some categories such as pet grooming, as consumers are increasingly having problems meeting ends meet in this high inflationary environment. In addition, the company delivered mixed fourth quarter results and reduced fiscal 2023 revenue guidance somewhat earlier this month.
The company's CEO gave the stock a vote of confidence when he added more than $500,000 of new stock to his holdings earlier this week. It was the first insider purchase in this equity in more than a year. The company does have a slug of debt, which has been an additional headwind for the stock as higher interest rates have punished these names in the market. The company saw interest expenses shoot up 45% or $8.5 million on a year-over-year basis in the fourth quarter. Petco, however, has ample liquidity and is using its free cash flow to pay down debt on its balance sheet. Even with a tough environment for consumers, the company should remain solidly profitable and keep churning out sales gains in the low single digits while waiting for the economy to improve.
WOOF is much cheaper than competitors like Chewy (CHWY) and Freshpet (FRPT) vis a vis an earnings before interest, taxes, depreciation, and amortization valuation, albeit with much lower annual revenue growth. And Petco has achieved profitability in contrast to these peers. While this week's stock purchase by the company's CEO might not mark the bottom for the stock, it does seem a decent entry point here. I like the company's longer term future and I don't mind slowly accumulating a stake in this name near 52-week lows. The stock trades at less than a .5 price to sales ratio. I like a covered call strategy to build a stake in WOOF as it provides decent downside protection, the options are liquid on this name, and it will be solidly profitable if WOOF trades sideways for a while as well.
Here is how I would open a small position in WOOF via covered call orders. Using the December $10 call strikes, fashion a covered call order with a net debit in the $7.60 to $7.70 a share range (net stock price - option premium). This strategy provides downside protection of 15%, with 30% potential upside if WOOF regains just a bit mojo by yearend.