uptickAs 2015 hits the homestretch, all signs indicate that the pet industry is poised to outperform expectations for the calendar year. According to the American Pet Products Association (APPA), industry growth for 2015 was projected at just under 4.4%, a slight acceleration from 2014’s growth rate and a reversal of a four-year growth deceleration trend.

The reasons for slowing industry growth are structural in nature.  For total industry performance to accelerate we need more pet parents with larger disposable incomes.  Working against those realities are macroeconomics and population dynamics.  Pet owners are experiencing rising costs for both products and services, but are not enjoying higher wages or wealth creation through the stock market.  The Baby Boomers, the largest pet owning generation, is also aging out while Millennials, who are delaying home formation, are aging in.  The pet industry is not made up of alchemists after all.

As industry growth slows to a more modest pace, consolidation accelerates.  Pet industry M&A transactions will outpace private placements in 2015, extending a three year trend not seen since the most recent recession.  However, from this lull we expect renewal to emerge as market opportunities emerge from areas abandoned by acquired companies.

As we look back on 2015, as industry observers, here are the key themes and trends that resonate with us:

  • Growth on Pace for Uptick. Since 2010, the pet industry has experienced slowing sequential growth rates as measured by the APPA. While total industry spend has increased nearly $10 billion, annual growth has fallen from 6.2% in 2010 to 4.2% in 2014. Against a backdrop of slow/flat pet population growth and a waning pet food upgrade cycle, we questioned the potential for growth to accelerated in 2015. However, as the year enters the final quarter, all signs point to modest improvement in the industry. Improving adoption trends, increased spend on pet healthcare, and falling channel barriers are all contributing to a stabilization of the industry’s growth trajectory.
  • Emphasis on Big Deals Continues. In the past 18 months, the pet industry has witnessed five M&A transactions in excess of a billion dollars, highlighted by the acquisitions of PetSmart ($8.9 billion) and Big Heart Brands ($5.8 billion). Seven deals involving companies valued at between $250 million – $1 billion were also consummated in that period. In our tracking of pet M&A, no other period exhibits a similar velocity involving major industry players. Add to this dynamic the Blue Buffalo IPO, which is now valued at $4.4 billion, and a potential IPO or M&A trade involving Petco Animal Supplies, this period becomes even more distinguished. The implication is that large strategic acquirers have become focused on market share and economies of scale, as opposed to acquired innovation. This may open up the market for more private and growth equity transactions as the revenue hurdle for a strategic takeout pushes higher.
  • Facility Investments Paying Off. In the pre-recession period, investments in fixed assets were seen as a sub-optimal use of capital. The abundance of third party manufacturing capacity abroad led to asset light models being favored in pet consumables. Based on the perceived premium multiples garnered in recent transactions involving vertically integrated players and the robust growth of independent brands with owned production assets that thesis appears to have come full circle. As domestic capacity in key sub-segments has become constrained, those with existing infrastructure are able to provide supply chain surety to consumers that others can’t match, proving a meaningful form of differentiation. “Made in the USA” claims for consumables is important to pet specialty retailers and premium customers.
  • Signs Point to Petco Trade Sale, but Not a Merger. While the performance of pet industry IPOs have been strong out of the gate, that momentum has been short lived. Even Blue Buffalo, which had a strong IPO debut, is down 28% from its offering price, relative to the S&P 500 which was off 8.6% during that same period. Given that broader market volatility shows no signs of abating, a trade sale for Petco looks increasingly likely. Several parties who pursued the PetSmart take private are actively evaluating the business. Additionally, it has been reported that merger talks with PetSmart are also under consideration, after having been eschewed less than a year ago by Petco’s backers over antitrust concerns. While a merger with its rival would make sense financially, the potential for a deal to clear antitrust is at best a coin-toss. Absent a broad market definition for the sales of pet products, the combined Petco/PetSmart would have untenable market share. Even a broad industry definition would likely result in scrutiny over the concentration of premium and super premium pet food sales controlled by the top two specialty chains. At the very least a merger would result in significant door closures. We think the risks may be too much to overcome, making a private equity deal the most likely outcome.

For a copy of our Pet Industry Report – Fall 2015, please contact me directly.

/bryan

Note: This blog is for informational purposes only. The opinions expressed reflect my view as of the publishing date, which are subject to change.  While this post utilizes data sources I consider reliable, I cannot guarantee the accuracy of any third party cited herein.

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