Fresh off our visit to Global Pet Expo in Orlando, Florida, I am pleased to offer you my updated views on the pet industry.   The timing of this reports reflects my intended go forward publishing calendar — post Global Pet Expo for spring, and post SuperZoo for fall.   As always your comments and feedback are welcome.  Full access of the report is always available via email.

/bryan

—————————————-

The factory of the future will have only two employees, a man and a dog.  The man will be there to feed the dog.  The dog will be there to keep the man from touching the equipment. — Warren Bennis

Global Pet Expo was by all measures a solid show — more exhibitors, more attendees,  and more hype.   And while the convention did a great job of displaying how far the industry has come in the past 5-years, it also did little to create dialog regarding the challenges the industry will face in the near to medium term.

While I remain bullish on the pet industry, I try to take a balanced perspective allowing myself to be guided by the facts; I’m a realist mixed with a pinch of idealism.  To me, there is plenty to indicate that the pace of innovation  within the industry has slowed over the past 12-months.   Everything I saw at Global Pet Expo was incremental in nature — new companies offering “me too” product, product companies offering solutions that address very narrow niches, and a fair amount of “packaging updates” (albeit nice ones).   As an example, I don’t believe a company should exist just because its products are made from recycled material — there as to be more.  Further, my dialogs with pet food manufacturers and distributors suggest the segment did not have a cohesive plan for the pending inflationary cycle that will begin to manifest itself in the second half of 2011.

To the positive, industry fundamentals remain solid.  According to the American Pet Products Association the industry grew 6.1% in 2010 and is expected to grow another 5.1% in 2011.  The pet population is growing driven by an increase in the number of multi-pet households.   Spend on pets as a percentage of personal consumption reached an all time high in November 2010 according to the Bureau of Economic Analysis.   Further, most of the major pet companies produced solid growth in 2010 (Central Garden & Pet, the notable exception).

As always, PetSmart provides a great window into the state of consumer pet spend.   The company’s equity valuation handily outperformed the S&P500 during the second half of 2010, increasing 33.1% versus 14.2% for the S&P500.  Further, same store sales averaged 5.9% over the second half of 2010 versus 0.9% for the prior year period.   The company continues to out comp Walmart and Target with respect to same store sales.   Sales were up, earnings were up, comp transactions were  up.   Further, PetSmart management expressed strong satisfaction with the early results of its proprietary product launched, stated that private label and exclusive product sales had increased in from 16% to 18% in the fourth quarter of 2010 versus a five year target of 25%.

Periods of lower innovation tend to drive more active consolidation as established companies seek to buy strong product development companies and expand market share.   What is notable is that these efforts continue to be driven by the private equity community.    Most of the notable acquisitions of the past six months, save for Nestle’s acquisition of Waggin Train and The Hillman Company’s acquisition of TagWorks, LLC, have involved private equity.  However, as these two deals indicate a consolidator market is emerging for properties with a threshold level of revenues +/- $50 million.

Where we go from here is going to be a function of whether expectations converge.   Market multiples of public traded pet companies continue to expand.   This pattern is relatively consistent with other stock categories that have significant exposure to discretionary consumer spending; in short the market is pricing in a recovery.    These multiples along with the deals of 2007 – 2009 continue to set valuation expectations for sellers.   However, buyers seem increasingly less willing to pay a significant premium for pet properties, in part because there are other segments of the market that appear more attractively priced.   Further, one has to believe the market will separate into the leaders and the laggards, with the leaders demonstrating true innovation and enjoying the valuation premium that goes with that disposition.

Look for the balance of 2011 to be instrumental in setting the tone for the balance of the cycle.  A strong year for the industry could set of us off again, just like 2007.

/bryan

Advertisements