PetSmart's loan slips after promotional missteps and ongoing losses

NEW YORK (LPC) - US pet supplies retailer PetSmart’s US$4.2bn leveraged loan dipped in the secondary market after the company posted another weak quarter of earnings as it continues to spend aggressively to grow online to offset slowing traffic at its brick-and-mortar operations, sources said.

FILE PHOTO: The Petsmart store in Westminster, Colorado is seen November 18, 2014. REUTERS/Rick Wilking

The US$4.2bn term loan B, which was arranged in 2015 to back PetSmart’s leveraged buyout, fell to 78.25-78.75 from 79.5-80 after earnings were released last week. The loan matures in 2022 and pays 300bp over Libor with a 1% Libor floor.

PetSmart, which is owned by a consortium of investors led by private equity firm BC Partners, does not file financials or hold public earnings calls.

Declining Ebitda, or earnings before interest, taxes, depreciation and amortization, has pushed leverage up to 7.0 times on a secured basis and roughly 10.0 times total, based on US$6.195bn in secured debt, US$8.745bn in total debt and US$884m in last 12-months’ Ebitda, up from 6.2 times and 8.7 times, respectively, at the end of the third quarter, two of the sources said. The company is still generating cash, however.

Despite revenue gains owing to, the company’s growth engine, Ebitda fell 37% to US$203m from US$324m, as costs associated with acquiring customers continued to drive losses at Chewy. Excluding Chewy, Ebitda dropped 18% to US$265m. The company bought Chewy in May 2017 for roughly US$3bn to shore up its declining brick-and-mortar business and help it compete with e-commerce companies like

While the implied negative US$62m of Ebitda at Chewy was in line with investor expectations, the Ebitda decline in the legacy business was higher than anticipated, the sources said.

The company told investors on the earnings call that margins at the legacy business suffered after incentive programs in the fourth quarter failed to drive traffic into stores, but it expected to see higher margins going forward by adjusting promotions at brick-and-mortar locations, sources said.

“[Legacy] PetSmart should stabilize, they have services like grooming that help, though no one’s sure how long it will take,” one of the sources said.

PetSmart reported a roughly 33% jump in revenue for the fourth quarter ending January 31 to US$2.51bn from US$1.9bn, the sources said.

Excluding Chewy, revenue fell 1.7% to US$1.86bn from US$1.9bn, in line with the 1.5% drop in revenue in the legacy business in the third quarter.

While year-on-year comparisons do not yet include Chewy, its revenue was 99% higher than the same period in 2016, the sources said.

“Chewy is more than making up for the losses at the legacy business,” one of the sources said.

Same-store sales for the fourth quarter were down 3.8%, after falling 3% in the third quarter, 5.3% in the second quarter and 5.9% in the first quarter. The numbers showed an average quarterly drop of 4.5% for all of 2017.

The fourth quarter results were still favorable compared to a negative 4.6% same-store sales figure a year earlier, which was partly due to a failed negotiation with Colgate-Palmolive over mass distribution of its Science Diet pet food that led PetSmart to pull the product from its shelves.

On the third quarter earnings call, PetSmart said that the Science Diet issue accounted for three-quarters of the same-store sales decline, and that comparisons should improve every quarter and start to turn positive.

Management walked back those comments on the fourth quarter call and said that just one-quarter of the drop was due to Colgate and attributed the remainder to customers migrating online, in a sign that the operating environment for the brick-and-mortar business is posing a larger challenge than previously thought, one of the sources said.

The company did not discuss its plans to open new stores beyond those it has already committed to open in 2018, but indicated its strategy would likely change if same-store sales remain negative.

The company told investors the search for a CEO replacement is going well, one of the sources said. It has been operating under interim management since last August, when its CEO resigned. Chewy’s CEO also stepped down in March and was replaced by the company’s COO.

Concerns have arisen about the owners’ ability to spin off Chewy using the restricted payments and permitted investments capacity provided for in the company’s debt documents. However, some investors believe that Chewy’s valuation has increased and is now in excess of the current capacity available under those baskets, which could preempt such a move or limit how much of the business could be spun off, sources said.

BC Partners declined to comment. PetSmart did not respond to requests for comment.