Petco's Q1 2024 earnings call presented a revitalized company laser-focused on profitability. The narrative focused heavily on 'retail fundamentals' and cost transformation, with Interim CEO Mike Mohan emphasizing a return to merchandising excellence, marketing effectiveness, and disciplined inventory management. But hidden within the positive spin and talk of a 'fully integrated services offering' lies a potentially disturbing truth: Petco's much-touted veterinary strategy might be losing its luster.

While executives were quick to highlight the 10% growth in services, driven by 'ongoing strength in vet hospitals,' a closer examination of their actions and language reveals a potential shift in priorities. For the first time since their aggressive push into veterinary services, Petco has significantly scaled back its vet hospital expansion plans. Brian LaRose, CFO, stated they would only build 5-10 new locations in 2024, a dramatic drop compared to their previous ambitious rollout.

The reason? Capital preservation. LaRose emphasized their commitment to 'bending the profitability curve' and achieving free cash flow positivity, highlighting the 'powerful lever' of earnings over working capital improvements. While he insists the vet strategy remains 'strategic,' actions speak louder than words. The decision to dramatically curb expansion, despite claiming 'vet economics continue to track,' suggests a potential reality check hitting Petco's C-suite.

Could it be that the rosy picture painted around vet hospital profitability is fading? Are the 'halo effect' benefits to merchandise sales less than initially anticipated?

Why the Slowdown Raises Red Flags

Capital Intensity: Vet hospitals are expensive to build and operate. Petco's estimated cost per location is around $1.2-1.4 million, a significant investment in a year where they are striving for free cash flow positivity.

Maturation Timeline: New vet hospitals take time to ramp up to profitability. The slowed expansion suggests Petco might be experiencing longer-than-expected maturation timelines, impacting immediate earnings.

Competitive Landscape: The veterinary space is increasingly crowded. Aggressive expansion from independent vet groups, along with established players like VCA, creates a competitive landscape where achieving projected returns becomes more challenging.

The shift in focus toward 'retail fundamentals' could signal a strategic realignment. Instead of relying on the long game of veterinary services to drive profitability, Petco seems to be prioritizing its core retail business. This might involve streamlining the assortment, optimizing pricing to cater to value-conscious consumers, and enhancing the in-store experience to improve basket size and transaction volume.

While services still hold long-term potential for Petco, the reduced investment in vet hospitals raises questions. Is Petco experiencing a reality check on vet hospital profitability, leading to a strategic shift toward optimizing its core retail business for near-term gains?

Capital Expenditures: A Shift in Focus

The chart below illustrates Petco's capital expenditure guidance for 2024, down 47% year-over-year. This significant reduction, particularly in vet hospital expansion, suggests a prioritization of near-term profitability over long-term strategic investments.

This shift in approach toward a more conservative vet strategy, coupled with the laser-focus on profitability, could be a sign of things to come. While Petco remains a formidable player in the pet care industry, their ability to balance long-term strategic goals with near-term financial performance will be crucial for their future success. Investors and analysts will be eagerly watching the next few quarters for further clues regarding the true health of their veterinary ambitions.

"Fun Fact: Petco was founded in 1965 as a mail-order veterinary supply company, highlighting their long-standing connection to pet health."