What happened
Shares of Petco (NASDAQ: WOOF) were rolling over last month after the pet products retailer and services company faded on concerns about rising interest rates and in response to Walmart's latest entry into pet services.
According to data from S&P Global Market Intelligence, the stock finished the month down 20%.
As you can see from the chart below, that pullback primarily came as concerns about rising interest rates washed over the market in the middle of September.
So what
Pet stocks like Petco have a well-deserved reputation for being recession-proof as Americans will spend on their pets regardless of the strength of the economy.
However, Petco is facing two distinct forces in the current macro environment that have made the stock a loser. First, sales of pet products and services have cooled off following a pandemic-driven boom in adoptions, and pet stocks have sold off broadly in response to the slowdown. Chewy stock even reached an all-time low recently.
Petco, meanwhile, faces its own distinct challenge in rising interest rates as much of the debt on its books is of the variable-rate variety, which has gotten significantly more expensive as rates have surged over the last two years.
For example, Petco took out a $1.7 billion loan two years ago that had a 3.5% interest rate at the time. Now, it's paying 9% on that debt, and interest payments sucked up nearly a quarter of its free cash flow in the second quarter.
Beyond the challenges in its financial house, Walmart also seems prepared to elbow its way into the pet services space. The retail giant said on Sept. 20 that it would open its first Pet Services center, offering veterinary care, grooming, and a self-serve dog wash at a store in Georgia.
Walmart already has vet clinics in more than 65 stores across the country, and the company is likely to expand the pet services centers if the first one is successful.
Now what
Petco went public in 2021 with a promising value proposition that it could combine the e-commerce presence of a company like Chewy with brick-and-mortar services like grooming and veterinary care.
While the top line has continued to grow with revenue up 3.4% in its most recent quarter, the company has been challenged on the bottom line in part because interest expense rose 72% to $37.5 million in its most recent quarter.
That puts additional strain on profitability, and elevated interest rates likely mean that those payments aren't going away anytime soon. Investors banking on a comeback will have to be patient.
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Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chewy and Walmart. The Motley Fool has a disclosure policy.
