• by Sarah Mahoney  @mahoney_sarah, November 30, 2023

Anyone looking for ear scritches or belly rubs might want to steer clear of Petco Health + Wellness this week.

The retailer surprised observers by missing financial forecasts, with sales and profits declining in the third quarter. Baird Securities downgraded the company as a result.

Net revenue slipped 0.5% to $1.49 billion, while comparable sales were flat.

The San Diego-based company says that while it saw gains in consumables, up 2%, and services division, up 15%, sales in supplies and companion animal business dropped 9% versus the prior year.

It posted a net loss of $1.24 billion, compared to net income of $19.9 million in the comparable period of 2022.

"Our third quarter results were below our expectations as we continue to navigate a challenging consumer environment,” says Ron Coughlin, the company’s chief executive officer, in the announcement. “We are taking swift and decisive action to improve the performance of our business by broadening our appeal with customers and tightly managing costs and capital.”

A major change includes the upcoming launch of cat and dog food value brands, a significant pivot from Petco’s recent emphasis on premium and fresh pet foods.

The company used the earnings conference call to outline an operational “reset,” outlining new ways to cut costs.

Baird downgraded Petco to a neutral rating.

“The timing of profit stabilization is proving more elusive than we anticipated,” writes Peter S. Benedict, an analyst who follows the company for Baird. While noting that the reset is understandable, the cost-savings plan “brings an added level of uncertainty, given the higher mix of lower margin products and increased competitive overlap with discount players.”

The stepped-up focus on more affordable pet foods means lower profit margins. Petco executives believe the net result will be beneficial, winning over shoppers who’ll spend more on services and hard goods.

Observers aren’t so sure. Seth Basham, an analyst who follows the company for Wedbush, says he is not convinced those looking for bargain pet food can be tempted to spend more. “They are value-conscious for a reason,” he writes.

He notes that Petco’s proposed pricing and product changes will likely take multiple quarters to have an impact.

“We also see some risk for incremental trade down from existing Petco shoppers that are now presented with more affordable pet food and treat alternatives,” he adds. “This pivot to winning back value-conscious customers comes with risk and, at the very least, a lower overall gross margin trajectory.”