And we are back…

The pet industry continues to evolve towards its new normal.  However, while it appears the volatility within the industry has decreased, tremors continue and several events could catalyze a second wave of transformational change.  Central going forward is that the industry now finds itself facing some new pain points with no clear path to resolution.

Of increasing significance, latency between consumer trends and pet trends has compressed from years to months, which will put immense pressure on the industry’s antiquated regulatory framework. Consumer demand for pet products that incorporate CBD, human diet concepts such as Keto and Paleo, and protein alternatives is significant but lacks regulatory and, in some cases, legal clarity. That has not stopped manufacturers or retailers from bringing these products to market in order to satisfy demand. If AAFCO cannot evolve to become more nimble and responsive, the industry will become more risky to all involved.

Also of significance, is that the risk associated with the repositioning of Petco and PetSmart could result in major downstream implications. As Petco forges ahead with its new wellness enabled vision, PetSmart has largely stood still lacking financial flexibility.  The success of Petco’s strategy could put pressure on PetSmart to sell or IPO Chewy, it’s most valuable liquid asset. Notably, a Chew S-1 was filed on April 29th (see here). Tepid operational results for Petco or from investors during a Chewy IPO roadshow, could place these two organizations on a merger path in order to remain relevant.

Slower industry growth is driving consolidation, a theme that will continue for the foreseeable future. The cost of doing business in the pet industry has increased as physical and online retailers monetize their market positions, making it more difficult for midsized and emerging brands to compete. Given the pace of change, strategics are under more pressure to acquire assets that enable them to meet emerging customer needs, or risk losing out on the ability to monetize faster growing market opportunities. Private equity is leading the consolidation charge due to broader business malaise prevalent among large strategics, which will enhance focus on profitability as the key criteria underlying acquisitions and put downward pressure on valuations

Notwithstanding slower growth and more turbulent competitive dynamics, we believe the current environment offers a market opportunity that may not manifest itself again for some time.  The other key trends we are keeping our eye include:

  • Blue Buffalo Banks Further on FDM. General Mills announced that they intend to double Blue Buffalo’s retail availability by April 2019. Central to this strategy will be launching Wilderness in FDM. When Blue transitioned Life Protection Formula in August 2017, it communicated its intention to protect the pet specialty channel by preserving exclusive access to its others brands. The quest for growth and profits rendered that commitment fleeting. By the end of April, according to General Mills earnings presentation Blue will have a retail ACV of 65%, up from 32% in October 2018.  Retail sales declines in pet specialty necessitated the move according to General Mills executive leadership. Notably, Blue also posted 24% ecommerce growth for the nine months ending February 2019.  If there is anything left in the relationship between Blue and pet specialty we will soon find out.
  • Amazon Accelerates but Housebrands Not a Category Killer. According to Packaged Facts, Amazon generated pet category sales of $3.3 billion in 2018, giving it a 6% share of the market. Amazon pet food sales exceeded $1 billion in 2018, up over 20%.  However, Amazon’s own housebrand Wag, launched in mid-2018, only accounted for $2 million of these sales. While Amazon housebrand sales will invariably increase over time and benefit from the launch of complementary brands, such as Solimo, owning the buy box is not yet translating into changing consumer behavior. Most Wag and Solimo product ratings are 3.5 to 4 stars, evidence of mix sentiment, and the launch has been plagued by production issues. A study by Marketplace Pulse suggested that Amazon housebrands across categories were having limited impact on brand sales online. With estimates for online penetration of pet food sales reaching as high as 50% over time, Amazon stands to benefit anyway you look at it.
  • Petco Launches Repositioning Strategy. Petco is ushering in a comprehensive new strategy firmly rooted in the health and wellness driver of industry growth. Petco’s approach involves eliminating products whose formulations feature artificial ingredients. As part of this process, Petco will seek to transition customers in many leading national brands to its housebrands and other channel dedicated brands. Criticism has ensued as Petco’s housebrand formulations may not fully comply with their own standards and many brands they are removing appear to be for financial or competitive reasons. Additionally, Petco launched its PetCoach store which “offers the highest quality suite of personalized pet services, products and experiences – all designed through a veterinary lens – to address total pet health and wellness.” While its competitor runs in place, we applaud Petco for its efforts to reframe its appeal and relevancy to pet owners. However, if traffic and transactions don’t materialize, Petco may lack the flexibility for a further pivot. Get your magic 8-ball ready.
  • Follow the Funds to See the Industry’s Future. 2018 was a record year for industry consolidation, but it also outperformed in terms of private placements, as equity flowed into the category at record levels. Over $1 billion of equity capital was invested in pet related enterprises since 2017. Notably, the year was punctuated by larger deals, with the median deal size of $45 million among transactions whose proceeds yielded more than $5 million. Investments in dog-walking apps accounted for 40% of deal value, but 23% went into ingredient manufacturing companies, with an additional 7% flowing to direct-to-consumer dog food brands. Institutional equity is flocking to these opportunities because they are not well served by existing market participants. The deals of today will fuel the exits three to five years down the road, which will only serve to extend the consolidation cycle. However, the subsectors attracting capital speak to a much broader market opportunity within the industry.

As always, if you are interested in accessing our full report you can reach out to 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.