Petmed Express Inc (PETS): Could This Online Pet Supplier Join the Seattle Web Giant’s Empire?

Amazon.com, Inc. (NASDAQ:AMZN)’s primary focus may be on its Kindle technology and digital media franchise, but it continues to add products to the world’s largest marketplace. When building product categories are not cost effective, it acquires value-enhancing brands, like its purchase of online shoe purveyor Zappos.

With $52 billion in annual sales, the pet products business is also on the company’s radar, which it participates in through multiple channels including its Wag.com unit. However, in a bid to put competitors in the rear-view mirror, could the leading pet pharmacy owner Petmed Express Inc (NASDAQ:PETS) be on Amazon.com, Inc. (NASDAQ:AMZN)’s list of targets?

What’s the value?

Founded in 1996, Petmed Express Inc (NASDAQ:PETS) offers a broad assortment of prescription and non-prescription pet medications, as well as pet supplies, through its namesake website and call centers. The company has been aided by rising per capita spending by pet owners on their canine and feline friends, with the American Pet Products Manufacturers Association estimating that 2012 industry sales were $52.9 billion, up 4.7% versus the prior year. Petmed Express Inc (NASDAQ:PETS) has also benefited from consumers’ continual search for the best price, which the company delivers by capitalizing on its volume purchase discounts.

In its latest fiscal year, Petmed Express Inc (NASDAQ:PETS) posted mixed results, with a 4.4% decline in total revenue, but a 3.9% increase in operating income. The company’s top-line was hurt by a lower average customer order size and the unavailability of certain popular products due to manufacturer production delays. On the upside, PetMed Express’ operating margin received a boost from lower advertising spending, as management pursued lower cost, online advertising channels.

Given Petmed Express Inc (NASDAQ:PETS)’ rising customer acquisition costs, up 5% for the period, the company could get significant mileage from being part of Amazon.com, Inc. (NASDAQ:AMZN)’s network of properties and its ubiquitous brand recognition. The internet giant could certainly reverse Petmed Express Inc (NASDAQ:PETS)’ declining operating margin by leveraging its own efficient fulfillment and marketing operations, thereby driving a greater percentage of gross profit to the bottom line. At a current price to operating profit multiple of 11, an acquisition would be a relatively cheap way for Amazon to gain the top position in the pet medications segment.

Knocking on the door

Of course, pet retailing giant PetSmart, Inc. (NASDAQ:PETM) has the most to lose from Amazon’s growing ambitions in the pet products space. The company is the largest specialty retailer focused on the pet sector, with over 1,200 stores in the U.S., Canada, and Puerto Rico as of December 2012. However, PetSmart, Inc. (NASDAQ:PETM) generates over half of its total sales from the consumables product area, like food and nutritional items, which are susceptible to cheaper prices from online competitors.