PetSmart Creditors Said to Query New Stores as Traffic Slows

(Bloomberg) -- Something’s not adding up for PetSmart Inc. lenders.

The company is already loaded with debt from a pricey e-commerce acquisition in 2017, and earnings have plunged as the $3 billion takeover of proves tough to integrate. Yet PetSmart’s managers plan to open as many as 60 new stores in 2018--after adding more than 100 over the past two years--according to people who listened to an earnings call late Thursday.

Some holders of the retailer’s $8 billion in bonds and loans questioned the brick-and-mortar expansion during the conference call, given pervasive weakness in retailing and PetSmart’s apparent goal of moving more business online, the people said. They asked for anonymity because the call for the closely held company was open only to investors and other invited market participants. The doubts are reflected in PetSmart’s debt, with some of its bonds selling for less than 60 cents on the dollar.

PetSmart executives on the conference call acknowledged the decline in revenue from existing stores even as they discussed opening the new ones, which it estimates will cost $160 million in capital spending, the people said. A drop in foot traffic and the shift to online shopping contributed to the fourth quarter’s 3.8 percent decline in comparable-store sales, which excludes Chewy, executives told investors. While the pet industry is expanding, the brick-and-mortar role is shrinking, they said.

Pressed during the call about PetSmart’s plans to open new stores, management said that it had to honor previous “commitments” that had been made prior to the Chewy acquisition and before store traffic had slowed, the people said.

PetSmart Creditors Said to Query New Stores as Traffic Slows

PetSmart didn’t give guidance for 2018 or an update on its search for a new chief executive, the people said. Michael Massey, who became CEO after PetSmart’s $8.3 billion leveraged buyout in 2015, resigned in August. A representative for the Phoenix-based chain declined to comment, but management said on the call that the deal’s strategic rationale remains strong, according to the people.

The retailer’s adjusted earnings before interest, taxes, depreciation and amortization, or Ebitda, fell to $203 million in the quarter, or $264.5 million adjusted for the Chewy deal, people said. That was down from $324 million the prior year, when Chewy wasn’t included.

Chewy has taken market share from competitors, according to the company, but its margins were slimmer than at PetSmart’s physical stores, with Chewy’s fourth-quarter gross margin at 8.4 percent, the people said.

Consolidated gross margin totaled 25.8 percent in the fourth quarter, or 31.9 percent when excluding Chewy, down from 34 percent gross margin in the prior-year quarter, which excluded Chewy, the people said.

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