Despite a challenging backdrop for the U.S. consumer, the pet industry continues to perform at or above expectations. While the pet market has not proven to be “recession proof”, as touted by many, key pet verticals have demonstrated strong resistance to the macro-economic turmoil impacting the broader market. Notably, an earnings recovery, beginning in late 2008, sent equity values of core publicly traded pet companies higher. This peer group out performed the S&P500 by ~ 16% in 2009.
While the macro outlook remains strong, a look into the performance of PetSmart, a proxy for pet retail, provides insight into the challenges facing the industry. PetSmart’s equity value increased 44% in 2009, on the back of a strong rally (31%) in the fourth quarter. However, a deeper look at the numbers reveals the impact the economic downturn had on the retail segment. Notably, growth in average ticket size decelerated in 2009 and traffic volume continued to slow, despite core consumers seeking lower price alternatives and one-stop-shop solutions. Further, a considerable amount of growth over the past two years was driven by commodity price inflation, mainly in the food category – but sales comps, excluding inflation, remained positive through 3Q09. PetSmart’s management issued strong guidance for 4Q09; the company produced its first positive units comp since 1Q07; hardgoods comps continue to be negative, but are improving; service sales increased 8.0%, after declining 9.3% in 3Q09 — grooming outperformed training and hotels.
Throughout 2010, we encourage industry followers to keep an eye on PetSmart, as its fortunes will provide a very good proxy into the health of the industry. In addition to keeping a keen eye on retail, here are other key trends we are tracking for 2010.
Facing the Facts
The reality is that the growth rate of the companion animal population is moderating, which will impact prospects for the industry. That said, the future still looks bright. The humanization of pets thesis remains strong, but growth will not be industry wide in the near term as economically challenged consumers face difficult purchasing decisions. We expect sectors and products that tap into the core themes of value, health and wellness, and convenience to outperform the industry at large. International opportunities will also be a source of growth for leading domestic suppliers.
Retail Landscape Continues to Evolve
In 2009, PetSmart and Petco lost market share to other big box retailers, grocery and independent pet specialty. Wal Mart has established itself as a major force in mid-range pet retail, providing a compelling one-stop-shop solution. Independent pet specialty continues to deliver a more attractive product mix and service solution for premium customers. Recovery in generic foods enabled supermarkets and the natural channel to rebound. These realities are forcing changes into the PetSmart and Petco business models. PetSmart is trying to create stronger customer bonds through adoption and services, which other channels cannot match, while Petco has launched “unleashed by Petco” to compete directly with independent pet specialty chains. We expect further changes from Petco and PetSmart in an effort to protect share.
Healthcare in Focus
Pet health and wellness remains top of mind for pet owners due to the rising cost of care for pets. Consumers continue to seek product solutions that deliver perceived health benefits to their companion animals. Additionally, they are proactively trying to control health care costs by purchasing pet insurance products, products that may mitigate or delay large health related expenditures, and trading down to generics for pet prescriptions. End of life care has become particularly challenging in light of current economic realities
Transaction Environment Transition
Over the past two years, the industry has seen capital inflows, primarily in the form of growth equity. While the pet industry remains a key target for consumer-oriented equity funds, the transaction landscape is likely to be characterized by a greater M&A orientation. Henry Schein Animal Health/Butler Animal Health, Pet Valu/Roark Capital, International Absorbents/Kinderhook Industries, and the pending sale of Pets at Home (UK) are recent examples of what we see as an emerging trend. We anticipate strategics will begin to use their balance sheets to purchase growth. Lacking access to cheap debt, private equity buyers will be at a disadvantage.
As always, our full industry update is available upon request.
/bryan







The fall trade show season for the retail segment of the pet industry has come and gone. From a macro perspective, the industry continues to thrive. Not only is innovation accelerating, but the core themes around humanization, health and wellness and convenience remain relevant. That said, things are not all sweetness and light. Of greatest significance is the reality that the economic contraction is having an impact on the industry, maybe not in the most obvious ways. Additionally, the H.H. Backer Pet Industry Trade Show was flat relative to SuperZoo, just two weeks prior. In the balance of this post, I discuss the key observations from walking the floor in Las Vegas and my interpretation of front line accounts from those attending H.H. Backer.
Andrew Lahde might not be a name you know well, but you should. Lahde was the sole principal at Lahde Capital Management, a small California hedge fund that returned between 866% and 1000% (depending on who you believe) within a year betting on the decline of the sub-prime mortgage market. And then he called it quits — at the peak of the market. Ladhe tapped because he, well, hated his job.
It’s hot, too hot for my liking. I’m sleeping in my basement with my dogs, while my hometown enjoys a record heat wave. While laying awake at night stewing in my own juices I began running through some old blog posts in my head and thought it might be worth revisiting the status of the financial markets.
The dark clouds that loomed over our economy appear to have dissipated, but the sun is still not shining. Even though second quarter economic data have brought hope for a steady economic recovery in late 2009, there are still systemic issues that require our attention; these issues have been brought on, in part, by efforts to keep the economic ship afloat.
Against a backdrop of macroeconomic uncertainty, the pet industry continues to thrive. While the prevailing theory that the industry is “recession proof” is being sternly tested, market fundamentals of pet ownership remain strong and consumers are skimping on themselves as opposed to their pets and/or children. Further, the premium demographic continues to have a voracious appetite for efficacious products that are good for their pets as well as the environment.

It has long been our view that the economic recovery will begin when some liquidity returns to the lending markets. Businesses rely on the ability to borrow cost-effective capital to underwrite their daily operations, and debt is an essential cog in leveraged transactions; purchase price multiples rely on it.
It’s been a while since I posted about the current state of our economy, its prospects for recovery and how that is impacting the transaction environment. It hasn’t been for lack of interest, but rather the pace of play with the dynamics changing at an alarmingly fast rate. Further, with the recent market up tick, I have been enjoying the sound of silence.