Petco's Q2 2026: Contradictions Emerge on Gross Margins, Store vs. E-commerce Focus, North Star Pillars, and Pricing Strategy

The above is the analysis of the conflicting points in this earnings call

Date of Call: None provided

Financials Results

• Revenue: Net sales down 2.3% YOY; comparable sales down 1.4%; two-year comp improved 130 bps sequentially (Q2 vs Q1).
• Gross Margin: 39.3%, up more than 120 bps YOY; minimal tariff impact in Q2; both products and services margins expanded.

Guidance:

• FY25 adjusted EBITDA outlook raised to $385M–$395M (~+16% vs prior outlook midpoint).
• FY25 net sales expected down low single digits YOY (includes store closures).
• Tariff headwinds to be meaningful in Q3 and most significant in Q4.
• Q3 adjusted EBITDA expected at $92M–$94M (~+15% YOY midpoint); Q3 net sales down low single digits; seasonally below Q2.
• FY25 depreciation ~$200M; net interest expense ~$130M.
• ~25 net store closures in FY25; capex ~$125M–$130M with ROIC focus.

Business Commentary:

• Financial Performance and Profitability Improvements:
• Petco reported increased operating income by over $40 million and generated more than $50 million in free cash flow in Q2.
• The company delivered $114 million in adjusted EBITDA for the quarter.

• The improvements were driven by a focus on operational excellence, inventory management, and strategic pricing decisions.

• Gross Margin Expansion:

• Petco achieved a gross margin expansion of over 120 basis points to 39.3% compared to the previous year.

• This was achieved through a more disciplined approach to average unit cost and average unit retail, along with improved pricing and promotional strategies.

• E-commerce and Digital Strategy:

• Petco is focused on enhancing its omnichannel experience, with a new leader for the e-commerce channel identified to drive improvements.

• The company aims to increase marketing efforts to invite new customers back to Petco.com, acknowledging the need to improve e-commerce performance.

• North Star Project and Customer Engagement:

• The North Star project aimed to reimagine key elements of Petco, including merchandising, services, and marketing.
• Initiatives such as reintroducing the "Where the Pets Go" tagline and hosting in-store events have improved customer engagement and satisfaction, as evidenced by increased NPS scores.

Sentiment Analysis:

• Management raised FY25 EBITDA guidance and delivered Q2 adjusted EBITDA of $114M (+$30M YOY; margin to 7.6% with ~220 bps expansion). Gross margin expanded >120 bps to 39.3%. Operating profit rose $41M to $43M and free cash flow exceeded $50M. While net sales fell 2.3% and tariffs will weigh more in H2, leaders emphasized disciplined pricing/promo, SG&A leverage, and progress in store fundamentals, supporting continued bottom-line improvement.

Q&A:

• Question from Michael Lasser (UBS): When should investors expect a return to positive comp—Q4 this year or 2026?
  Response: Positive comp is more likely in 2026; company remains in Phase 2 with Q3 the toughest compare.

• Question from Michael Lasser (UBS): Were gross margin gains mainly from online promo cleanup, and would stores be positive ex-ecomm?
  Response: Cleanup was heavier in e-commerce; stores were the focus and are improving, but store-only comp not quantified.

• Question from Steven Zaccone (Citi): Gross margin beat and tariff timing—how did it compare to expectations and what’s the back-half impact?
  Response: Gross margin expanded via AUR/AUC, pricing/promo discipline across products and services; tariffs were minimal in Q2, meaningful in Q3, and most significant in Q4.

• Question from Steven Zaccone (Citi): How are you using pricing in the back half?
  Response: Pricing actions continue with a consumer-first lens; approach has been in place all year and will persist into H2.

• Question from Jake Neibosh (Guggenheim): Update on planogram resets?
  Response: Dog/cat resets are complete, boosting on-shelf availability, labor productivity, and store profitability; more category resets are coming.

• Question from Jake Neibosh (Guggenheim): Any details on the North Star initiative?
  Response: Four pillars: elevate store experience, scale services, drive merchandising differentiation, and win in omnichannel.

• Question from Kamal Gajawala (Jefferies): Status of e-commerce pullback/retool and inventory levels?
  Response: E-comm is more profitable with a new leader fixing basics (speed, repeat delivery, scheduling); inventory down 9.5% YOY with better in-stocks; tight, well-governed buys.

• Question from Kamal Gajawala (Jefferies): What’s driving the NPS improvement?
  Response: Improved in-store experience from partner engagement and leadership focus is resonating with customers.

• Question from Kendall Toscano (Bank of America): What were transactions vs AUR trends?
  Response: Basket and UPT were healthy; transactions lagged and are the key focus, with events/marketing to drive traffic.

• Question from Kendall Toscano (Bank of America): Biggest remaining execution gaps before fully shifting to Phase 3?
  Response: Focus is shifting to reinvestment; margin runway remains via sourcing, pharmacy expansion, and rebuilding supplies.

• Question from Simeon Gutman (Morgan Stanley): Trends in pet families and customer behavior?
  Response: Category is roughly flat; Petco is holding share while prioritizing profit; shifting from bottom-funnel e-comm to LTV/omni and cross-selling services customers.

• Question from Simeon Gutman (Morgan Stanley): Any markdown risk from merchandise changes?
  Response: No significant risk expected; inventory governance is tight with fast-turn, seasonal, well-controlled buys.

• Question from Justin Kleber (Baird): Can you size the comp drag from promo cleanup and what is the underlying run-rate?
  Response: Too granular to quantify; Q3 is the hardest compare; stores are improving while e-comm cleanup continues.

• Question from Justin Kleber (Baird): Why does implied Q4 adjusted EBITDA step down?
  Response: Q4 faces the largest tariff headwinds; management is reserving funds for targeted investments and guarding against macro volatility.