PetSmart (PETM) impressively raised their quarterly dividend from 3 cents to 10 cents, effective for their fiscal second quarter ending July.  The substantial increase brings the yield on the stock up to about 2%, the board was able to return more earnings to shareholders because of substantial free cash flow.  Furthermore, they also plan to buy back about $350 million worth of shares over the next two and a half years, an outward signal that they think the stock is just too cheap.  This is an impressive showing of confidence from the management of the big-box pet supply store.

This comes as a bit of a surprise to us because you would think that pet supplies are a luxury item, after the necessities of food and veterinary expenses.  However, the retailer has consistently increased sales in the mid-single digits and earnings have stayed relatively constant through the recession.  This is one of the few retailers that has been able to keep the sales rolling in even as the economy has worsened.  It just goes to show you that people will cut back on their own expenses, but it is harder to say no when your furry friend wants a new toy or needs a bath.  If people are this willing to spend on pets when the money is tight, it stands to reason that it would improve when the economy is on firmer footing.

Wall Street retail analysts have been pretty quiet on PetSmart shares, as there has been only on major ratings change in the past six months (an upgrade to Buy at Piper Jaffray).  Similarly, at Ockham we have thought that PETM shares are Undervalued for some time now and nothing has changed greatly to change that view.  With both price-to-cash and price-to-sales metrics well below their historically normally levles for PetSmart, the valuation looks pretty compelling.  In addition, we are always interested to see when a firm’s management and board makes an aggressive statement about their optimism for the company’s future.  That is precisely what the company did today by increasing the dividend and signaling they believe the stock is undervalued, prompting the company to buyback its own stock.  Just last week, the company announced that a new CEO Bob Morgan will be stepping up to the top spot from his roles as COO and President.  We will be interested to see if he can continue the strong performance that the company has shown thus far in this recession.