Last week, we released our research on Petco's WOOF 0.00%↑ pre-earnings announcement and we were happy with the results [WOOF: Banking on the Pet Industry]. The company beat on all estimates and what seemed to be retail armageddon due to the likes of Target TGT 0.00%↑ and Walmart WMT 0.00%↑ had appeared not to spread to Petco. Due to this, the stock has rebounded ~13% off the lows of last Monday on strong earnings.
Our main thesis for Petco focused on building an “end-to-end” ecosystem that promotes and encourages pet parents to get all of their pet needs with them instead of shopping around.
One part of our thesis involved Petco’s “Vital Care” offering and how important it is in driving value, retention, and sales.
And our partners in the pet care centers love talking about Vital Care because they want to help the customers that shop. And Vital Care is a great way to provide value, $200 to $300 of value for an average customer. And so our partners in the pet care centers are signing people up left and right. They love this program.
To highlight the offering, I’ve included a snapshot for you below from their website. The remainder is a detailed breakdown of how company loyalty programs can drive value and provide stickiness for its customers that make it harder for them to switch to something else. Maybe this example can help you apply it to another company you are looking into.
So in order to show you just how this program is beneficial not just for the pet parent, but also for Petco, I’ll show the economics behind it below. First, let me start with my pet spending for my dog Pepper. To be conservative, I’ve only listed out things that would apply to the standard dog owner. All spending has been adjusted to a monthly price.
In total, I would spend $268.88 a month on the above, and if you look at the items I’ve listed, they’re all pretty standard stuff. Most of them you could argue are “staples” and while you could flex on pricing for food or cutting on toys/treats, this is more for illustrative purposes.
So now that we’ve set a baseline, it’s time to compare it to what it would cost via certain parameters. First, we have standard repeat ordering which grants the customer 5% off just for making it a repeat delivery, and Vital Care which has its benefits and perks above.
If we look at the differences between all three options, Vital Care saves me 12.5% a month (~$402 a year). This includes the $20 a month fee I need to pay to even get the perks. So, I save money by doing nothing other than just setting my goods on repeat and getting rewarded for doing so, not to mention I get Pal rewards on top of this (1 point per $1 spent, 167 points = $5 reward).
But before you jump to conclusions about this hurting the company via discounted items, you need to zoom out and look at the bigger picture. Management commentary from the most recent quarter on Vital Care mentioned,
As we said earlier, the Vital Care members have 1.5x higher traffic, 1.7x higher spend and generate 3x higher LTV. We're sourcing customers, both from brick-and-mortar as well as digitally.
So in essence, they spend more in general but for this example, let me highlight how they don’t really miss out too much. A point management said on the call too was in relation to how Vital Care members weren’t buying key goods prior to signing up.
…as we add Vital Care customers, 20% of them weren't buying food from us. 30% weren't buying or weren't having services from us. And so we're capturing that share of wallet, and we'll continue to do that.
So, if we take the above and apply it to a basket of 10 members, factoring in my example of spending above, the company loses out on $2.77 per customer, per month. However, this doesn’t factor in all the additional benefits not accounted for such as,
Increased spending in various categories
Other discounts not outlined in the membership
Additional add-ons for grooming services
Pet training, etc.
But what this grants the company is,
Growing recurring revenue (stable, easy to predict)
High retention (convenience = hard to convince someone to switch)
So now how is this playing out? Well, the company added ~160k subscriptions in Q4’21 bringing the total to 1.2 million, and then added another ~220k bringing the total to over 1.4 million in Q1’22, ahead of projections.
Taking my example above, yearly, that’s recurring revenue of ~$2,800 per subscriber. Factoring in what the current size of the membership (~1.4 million), that’s close to ~$300 million in recurring revenue. I will caveat this with the example I used above being for dogs (Vital Care is for dog and cat owners) so there’s variance in spend depending on size of dog, etc.
Given that Petco has a Pal Rewards program of over 24 million members, as Vital Care scales, more and more revenue for Petco will be recurring, stable, and high retention.
This will continue to put it in a great position to reinforce its defensive moat against competitors like Chewy CHWY 0.00%↑, Petsmart, Pet Supplies Plus, etc.
I hope you enjoyed this brief breakdown of Petco’s Vital Care offering, its significance in growing the ecosystem, and how other companies can or could be leveraging an offering like this now.
Until next time,
Paul Cerro | Cedar Grove Capital
Petco Vital Care Economics Fueling Growth