chewyChewy filed an S-1 on April 29th (see filing here).  The offering, if executed will be managed by Allen & Company, J.P. Morgan and Morgan Stanley (list in alphabetical order).  The company will trade under the CHWY ticker. As yet unclear is which exchange they intend to file on, the amount of proceeds (currently there is a $100 million placeholder, which is standard tactic), or the use of proceeds beyond working capital and general corporate purposes.  However, there is much to learn from the filing.

Before wading in, let’s a take a short trip down memory lane.  Chewy was acquired by PetSmart for $3 billion in May 2017. As part of a PetSmart refinancing, the buyer borrowed $8.2 billion and the private equity ownership syndicate injected $1.3 billion of equity.  The publicly traded component of that debt experienced significant volatility post issuance in-light-of PetSmart’s declining performance. The senior debt tranche traded as low as 70% in May 2018, before rebounding to current levels of 87.5%.  The junior tranche traded down to 48%, and today trades at 82.5%, reflecting a much rosier outlook. In June 2018, the ownership group took advantage of an asset stripping clause of the indenture to move 16.5% of the Chewy stock to an unrestricted subsidiary and dividend the parent company 20% of the stock.  The value of Chewy at that time was $4.45 billion and notably Chewy will no longer guarantee PetSmart’s debt. Through this process, the equity owners created a war chest that could be monetized to potentially generate a return on their investment or buy themselves out of debt purgatory at a discount. As you might expect, the creditors disputed the parent company’s legality to undertake the asset stripping, questioning whether the business was insolvent. Earlier this month, the two sides agreed to modify the terms of the debt in exchange for dropping the lawsuit.  The company’s bond prices spiked upon the announcement of the Chewy S-1 (source: Bloomberg):

petm bond

Now that we are all on the same page, let’s dig in.

Chewy.com generated $3.5 billion in Net Revenue during 2018, a growth rate of 68%.  This figure is slightly more than the estimate category sales on Amazon of $3.3B. Based on the S-1, ecommerce penetration in the category stands at 14%, with growth to 25% in 2022. Notably, Chewy generated a $268 million Net Loss, down from a $338 million Net Loss in 2017. The company warns that profitability may never be achieved, though this is a standard disclaimer.  The business currently has 10.6 million customers who order, on average, $334 annually. In 2012, this figure was $223, representing a ~ 7.0% six-year CAGR.  Notably, the company states that embedded growth among its customer base is 20%. This is growth that the Chewy would expect to experience through expansion of wallet share if it did not acquire any new customers.  Active customers spend, on average $500 in their second year and $750 after their sixth year, 1.5x their second year spend, which is usually their first full year on the platform.  The S-1 does not address customer churn.  Chewy generates approximately 80% of sales from consumables, of which 5.3% of total Net Sales are attributable to its housebrands.

While all the above is well and good and interesting, the most notable metric is the ratio of customer life-time-value to acquisition-cost, commonly referred to as LTV / CAC. This ratio speaks to how sustainable your customer acquisition engine is and a common predictor of future results. Based on the performance of its 2015 cohort, which is now three years aged, Chewy’s LTV / CAC was 2.4x.  The generally accepted benchmark for healthy performance on this metric is 3.0x, indicating some concern with the health of the business model and its ability to become profitable over time.

In thinking about what Chewy might be worth in an IPO, the comp that we gravitate towards is Wayfair.  The online retailer of furniture and home goods currently generates $6.8 billion of net sales, losing $404 million of EBITDA. The business currently trades at 2.1x LTM Revenues.  When you dig into the comp set analysts rely on in pricing the stock, that group trades at ~ 1.15x Fiscal 2018 Revenue and 1.0x Fiscal 2019 Revenue. This would value the business at $4.1 billion based on 2018 figures and $4.4 billion based on 2019 figures, assuming a 25% growth rate for 2019, with the caveat that no forward guidance is offered in the S-1 but in-line with the June 2018 valuation.

In our Spring Pet Industry report, we postulated that PetSmart may need to sell or IPO Chewy, but the realization of that option is manifesting itself sooner than we had anticipated.  The public markets are being tested with offerings of conceptually attractive businesses with a proclivity for losing money.  The net of this is the risk reward tradeoff being contemplated here is not without an ample helping of downside potential.

/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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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.

 

 

chicken_little_funny-t2Last week, PetSmart announced first quarter earnings. The company reported slowing growth and negative same store sales.  I believe it was the first negative comp quarter in 16 years for PetSmart. Management took full year comp store guidance down to zero, from 2%. The stock fell approximately 8% on the news, taking the year-to-date loss to -22%. Naturally, this has led some to question whether the sky is falling for PetSmart, the pet industry, or b0th.  To begin to answer these questions, we first need to uncouple them.

To assess the performance of PetSmart, separate and distinct from the industry, the best place to start seems to be in the context of broader retail.  Anyone who was surprised by softness in PetSmart’s numbers has probably not been keeping their pulse on the four wall retail environment. In January, 20 retailers pre-announced earnings shortfalls. This was the highest number post recession and on par with the levels the industry experienced in third and fourth quarter 2008. Howard Schultz blamed it on the Internet, others cited weather, consumer confidence, and wage stagnation. Notably, both Wal Mart (-0.4%) and Target (-2.5%) produced negative comps for the 1Q2014. We cataloged 1Q2014 revenue growth, EPS growth and performance versus guidance of some of the major big box retailers here — 1Q Retail EPS Performance. Notably, PetSmart was the only company within this comp group to exceed guidance on earnings. What this speaks to is the fact that PetSmart has a very good handle on the cost side of their business. While they experienced slight margin compression, unlike its peers PetSmart does not appear to be chasing the middle market consumer through a promotional discounting strategy. This underscores PetSmart’s relative market position in the industry as well as the ongoing attractiveness of the pet category.

When we shift our analytical purview to the broader industry, the cause and effect relationship is more apparent. While total consumer spending on pet products and services continues on a positive growth trajectory, total growth has been slowing, driven by a falling comps for pet products (see graph below).  What this demonstrates is that the industry is maturing and that drivers are changing.  As the pet food upgrade cycle has tapered products sales growth has slowed.  However, as a wellness focus has ascended, services revenue growth has accelerated.  Given that services is a much smaller part of PetSmart’s mix, it was bound to experience the malaise of the industry’s product sales growth trajectory.  PetSmart’s first quarter revenue growth was more or less inline with the growth in industry product sales.  Additionally, keep in mind that total pet industry sales, as measured by consumer expenditures by category, grew 12.6% between 2011 and 2013; at some point the “law of large numbers” catches up to everyone.Slide1A second lens we like to use to assess pet industry performance is the rate of adoptions.  An increase in ownership and multi-pet householders means an increase in expenditures.  However, as evidenced by the chart below, the growth rate for companion animal adoptions, as measured by shelters monitored by Pethealth, Inc., slowed markedly in 1Q2014, especially for dogs.  That said, a similar contraction was evident in 2011, a year of strong industry growth (4.7% according to the American Pet Products Association).  As such, we think it is too early to call it a year for the industry, but in combination with slowing pet products sales it is cause for some consternation.Slide2In looking at the total body of available data there is reason to be concerned about the pace of pet industry growth but not the overall health of the industry.  Slower growth has been anticipated and therefore should not come as a surprise. The industry has been defying skeptics for sometime, but all good things experience a tapering.  Further, it is too early to call the year from any analytical perspective.  The pet industry remains very attractive long term and while online players, adjacent market competitors, and emerging brands have eroded the leadership of both major retailers and product manufacturers, the threat to their overall industry position remains low.  Generally speaking, physical retail has experience a much more significant contraction, driven by share shift to mobile and online, recently even after you factor out the weather.  In that context one can view PetSmart’s performance in a relatively positive light.

I think I can say with authority, when it comes to all things pet there may be clouds in the sky, but it is not currently falling.

/bryan

images7CBOOO04

With the benefit of hindsight, we know the pet industry produced another solid year for performance in 2013, generating growth of 4.5%.  Industry revenues climbed to $55.7 billion, with growth exceeding forecast by 0.2%.  Revenues benefited from inflation of 1.3%, including food price inflation of 1.1%.  Growth was relatively uniform across the core segments with services (+5.0%) and veterinary care (+4.9%) leading the way.  While growth is projected to accelerate to 5.0% in 2014, we expect companies in the space to experience more widely divergent fates.  Our thesis is that the industry is undergoing structural changes that will result in stronger performance from the leaders and slower performance from the laggards.

Structural change is being driven by slower growth in the key drivers of performance over the past five years.  On the retail side, we are seeing smaller retail chains ascend at the expense of large pet specialty players. Notably, PetSmart same-store-sales slowed to 2.0% in 2H2013.  In contrast, PetSmart produced, on average, quarterly same-store-sales growth of 5.2%  from fiscal 2010 through 2Q2013.  Further, among top 25 pet retailers, 55% of box growth came outside of Petco/PetSmart in 2013, up from 41% in 2011. Finally, ecommerce growth in pet products is expected to accelerate from 35% in 2013 to 38% in 2014 as online pet venues both consolidate and proliferate.

Product manufacturers are also experiencing the impetus for change.  Looking for new sources of growth they are pursuing new channel strategies.  Big Heart Brands’ acquisition of Natural Balance Pet Foods and Nestle Purina PetCare’s acquisition of Zuke’s underscore this theme.  Notably,  the number of companies with pet specialty distribution that exhibited at Expo West (meaning they are looking for Whole Foods distribution) doubled in 2014. Additionally, the pending Blue Buffalo initial public offering is, in our view, a prelude for the brands entry to mass. Collectively, these companies will blur the lines between sales channels for pet consumers.

Net net, change is the air and change drives deal velocity. Below are the other key pet industry trends for 2014:

  • Prelude for Sale or a Move to Mass? In March, news leaked that Blue Buffalo Company Ltd. had selected underwriters for an anticipated 2014 initial public offering. When the company took a leveraged dividend in 2012, we predicted a sale or filing within three years. Blue generated $600 million in sales in 2013 and EBITDA margins are said to be nearing 20%. The company is approaching the size of The Nutro Company when it was acquired by Mars, Inc. While Blue has no lack of suitors, the purported asking price of $1.5 – $2.0 billion would be hard for even the largest companies to swallow in an environment where product recalls can rapidly erode brand equity. A listing would place a public sale price on the business, which may facilitate a transaction, but we think the more likely outcome is that Blue is headed to mass. The growth requirements for a public company are more than the pet specialty channel alone can support. If the brand jumps to FDM under its existing label, which we think is possible, you can add another brick in the wall of change.
  • Natural Leads Grocery Resurgence. Grocery has been steadily losing market share to pet specialty post recession. Simply put, FDM has been out-thought and out-merchandised. Lacking access to key independent brands coupled with limited selection depth, consumers have migrated their spend elsewhere. Grocery buyers and store planners did not recognize the strategic value in the pet aisle. However, this is changing. Major chains such as Kroger and Whole Foods have or are set to launch large pet assortments made up of staple, emerging, and house brands system-wide. Increasingly, brands are being built for the grocery channel or seeking to make the jump. Notably, the number of pet consumables companies exhibiting at Expo West doubled in 2014. Given its size and a lack of compelling incumbent brands, the pull of the FDM channel is strong. As the channel regains momentum outside of the natural and gourmet segments, it has the potential to change where consumers shop for premium and how brands are built.
  • Change Will Drive Deals. As manufacturers, retailers, distributors, and brands seek to align themselves with emerging realities, we expect to see increased deal activity. Deal velocity in sectors such as consumables should accelerate both acquisitions and private placements. Specialty retail, a sector whose transaction volume has been rather muted, should see a resurgence as leading micro-box and online platforms enjoy increased capital formation to expand their footprint or are acquired by mass and major pet specialty retailers seeking to expand omni-channel capabilities. For the most attractive properties, valuations will increase due to broader and deeper interest from buyers and investors.

Contact me for a copy for my report.

/bryan

Sources: APPA, Cleveland Research, New Hope Natural Media, Pet Business, Reuters, U.S. Bureau of Economic Activity

down but not outEarlier this week, PetSmart’s public equity was downgraded by Deutsche Bank equity research analyst Mike Baker. Baker put a “Sell” rating on the stock, reducing his 12-month price target price from $73 to $65, or approximately 11%. In formulating his rationale, Baker cites two main drivers.  First, he views recent traffic erosion at the best in class pet retailer as being a longer term trend as opposed to a short term aberration.  Baker anticipates that slowing sales in super premium pet food coupled with limited food price inflation is going to make 2014 comps hard to deliver.  He views premium food as a key traffic driver for PetSmart. Second, Baker believes that the long term threat of ecommerce in the pet space is real.  He states that once consumers begin to recognize that free shipping is available on most pet food orders that adoption rates will increase.  Baker cites a Pethealth, Inc. survey wherein 89% of pet owners would purchase pet food online if shipping were free.

Notably, Baker’s has been negative on the stock for some time.  He’s had a “Hold” rating on the stock since February 2011 when Petsmart’s public equity was trading at $42, versus the $72 it was trading at prior to Baker’s downgrade.  As such, he missed a 71% movement in the stock over that time period.  While the arguments above are not new (maybe you actually read them here over a year ago), they are real.  However, as I have come to believe there is more to the story, and PetSmart may have more mechanisms available to combat these trends or find other growth avenues than one might expect.  Further, Baker’s call comes at a time where there is a lot of noise in the market, and therefore the significance of his observations from a timing perspective may, in fact be, overblown.  I explore each of these concepts below:

  • Holiday retail was weak all over.  First and foremost fourth quarter was tough for premises based retailers.  Fewer shopping days between Thanksgiving and Christmas, weather problems across the country, and political problems in Washington all conspired to make things tough on four wall retailers.  November store comps across all retailers missed guidance and online took share as a result of time compression and weather impediments.  While we are readily aware that ecommerce is growing faster than traditional retail, there is a lot of noise in the numbers; once that noise dies down we expect PetSmart to do just fine versus guidance.  Baker did not mention the bathwater when he threw out the baby.
  • Premium food rotation is slowing but growth levers in the category remain.  We were ahead of the curve in calling a category slowdown, but our experience has been that the slow of erosion has not been as steep as anticipated.  The category, which at one time was likely growing 25%, is estimated to grow at between 15% – 18% in 2014, a decent clip.  History has demonstrated that major pet specialty retailers still have levers to pull to combat this trend. PetSmart is pursing private/exclusive label concepts in the category, expansion of space dedicated to felines, and alternative form factors/niche brands as a means to combat slowing growth.  The fact they are undertaking a large consumables reset tells me they saw this coming. Further, with a rising stock market and falling unemployment what is not to say that retailers won’t seek price increases absent commodity inflation?  Nothing really. 
  • Other drivers of traffic and earnings remain.  PetSmart has done a great job over the past cycle driving traffic organically.  They have not become overly aggressive with promotions and they are not buying business by offering emerging products companies sweetheart deals or subsidizing ecommerce.  Their exclusive brands are a strong driver of customer visits and will likely be extended in both new and current categories.  Further, as they ramp up their smaller format stores it will enable them to grow faster in secondary geographies.  Couple this with slightly more aggressive promotions offset by continued share repurchases, more consumers coming into the fold as adoptions increase with the economic recovery, and innovation in the services segment and PetSmart finds itself fairly well positioned to meet expectations.  
  • Ecommerce threat is real but the competitive tension goes both ways. As you are likely to be aware, we ascribed to the theory that ecommerce is skimming customers from major pet specialty retailers. However, it is also clear that they don’t yet view the battle as worth fighting…yet.  While PetSmart has made some tangible moves to better position itself online, it has multiple tricks in its bag that independent ecommerce retailers can’t match.  For every store, PetSmart has a warehouse.  They can offer in store pick-up and returns.  They can bundle products and services.  They can get aggressive with pricing.  Until they rollout their full artillery on this front it’s hard to conclude that they can’t win back that which has been lost to date.

Net net, PetSmart is facing a number of headwinds impacting growth.  Some of their challenges are industry realities and some are self created.  However, we think the timing of these observations is being discounted.  PetSmart has major resets underway to combat these very concerns and multiple levers to pull if, as, and when needed.  The glory days may be gone but we have learned the hard way to bet heavily against the concept.  

/bryan

willieWillie Nelson once said, the early bird may get the worm, but the second mouse gets the cheese.  In this case, I’m not sure which mouse I was.  Just days after I published my fall pet report a number of news worthy items came into focus that would have merited a mention in my industry report.  However, several of the items provide direct validation of the trends I have been discussing here over the past year.

Of greatest significance was the headlines coming out of PetSmart’s Analyst Day presentation.  Just prior to their Analyst Day presentation on October 17th, management announced that they expected third quarter same-store-sales (“SSS”) comps to come in below the anticipated range. Management believes 3Q13 SSS will come in at 2.0% – 2.5% versus prior guidance of 3.0% – 4.0%. PetSmart has not seen comps this slow since 2009. Notwithstanding the company’s issues with driving traffic, management is sticking by its full year EPS guidance.

Notably, as part of their presentation, PetSmart finally addressed its web strategy in some detail.  CEO David Lenhardt noted that how to remain relevant to consumers across channels was one of his biggest concerns and that the company would be investing more of its marketing budget and CRM resources online. He went on to detail several new ecommerce initiatives include in-store inventory look-up online, improved mobile experience online, in-store pick-up, and opening of a new West Coast distribution center which will reduce shipping times. Lenhardt continues to believe that PetSmart’s position as a destination retailer and its services platform will continue to enable it to compete effectively against other online players.

Over the past year, I have been highlighting the risk of the internet to PetSmart.  I’ve not been alone in ringing this bell.  While I believe PetSmart is uniquely situated to perform well online long term, my concern has been that they have not had a coherent strategy. In light of recent financial performance, including 3Q13 guidance, I have to believe that other online players are succeeding at eroding some of the premium customer base of PetSmart’s and Petco, especially among a younger demographic.  The company’s willingness to detail their plan, after years of side stepping the question, tells me there is some truth to this theorem. While online will result in erosion of hardgoods share, because of the wide availability of these products online, the concern will not reach its apex unless and until pet specialty sees consumables share erosion to online.

Second, the long running narrative linking imported pet jerky story product to numerous pet deaths finally hit the headlines. News about pet death related to foreign jerky products have appeared in nearly every major online publication during the past week. My historical conversations with domestic manufacturers has been that regulatory bodies are not doing enough to protect consumers from imported product and instead have been myopically focused at cracking down on domestic producers.  While it is terrible that so many pets had to fall ill before we got to this point, it now seems we have arrive at the moment where the paradigm shifts. When the dust settles the winners will be consumers and branded treat companies with domestic sourcing and production pedigrees.

Third, Whole Foods announced that they are launching a house brand of premium value oriented pet products. Whole Paws will consist of 24 SKUs addressing both dogs and cats cutting across multiple categories ranging from grain-free food and treats to cat litter.  The attempts of traditional grocery to cut into pet specialty sales are, like the jerky story, old hat for those that follow the industry closely, but the within the natural segment pet remains an under monetized opportunity. Grocery continues to leak share to both mass and pet specialty, due to price and assortment respectively.  However, natural has a real market opportunity in my opinion because it can provide grocery consumers more of a one-stop-shop.  While space limitations will ultimately cap the potential of the natural channel within pet, this product line launch is a clear demonstration that store managers are starting to understand the potential of pets within their channel.  Natural could become a nice bed for incubation of emerging brands with a wellness oriented theme much the way it was in natural beverage, healthy snacks, and gluten free foods.

Finally, the relative pull of the pet industry on owners was again affirmed to me when I became aware that pet owners will purchase nearly $330 million of costumes for their pet this year. This amounts to approximate 22 million consumers spending, on average $15 annually.  What consumer pressures on pet?

/bryan

 

dogThe pet industry continues to chug along.  Based on the information available, the industry posted strong growth in 2012 and is demonstrating all the critical signs of continued health — rising ownership levels, increasing innovation, expanding consumer spend, earnings growth from publicly traded participants, and active capital markets, both private placements and M&A.  In a year that was challenging due to economic uncertainty and political gridlock, the pet market did not miss a beat.

That said, we are only cautiously optimistic about 2013 on a relative basis. While we expect the industry to deliver a solid year when compared to other consumer segments, the pet market may have a difficult time out doing itself in 2013 for three reasons. First, the super premium food rotation that continues to compel growth in consumables is slowing, just not at the pace previously predicted.  At some point it will wane as a driver; 2013 may not be that year but the rally is clearly in the later innings, having only been extended by consumers concerns about quality and an increasing ability to finance said premium food purchases through rising disposable incomes. Second, the industry delivered incredible results in 2012, and comping against those results would be a challenge for an industry.  Notably, public traded pure-play pet companies grew earnings by over 21% in 2012, compared to 9.3% for the S&P500.  As a result, public traded equity prices of these pet companies outperformed the broader market by 25%. Finally, the industry is in a transitional period. Core pet owner demographics are changing, with Baby Boomer influence waning and GenX/GenY/Hispanic influence on the ascendency. Wellness as a central growth theme has benefited product sales, but veterinary volume growth remains poor. Until the product and services side are in sync, it will have difficulty achieving full impact. And channel shift from premises to online is taking place, albeit at a slow pace.

The industry also has meaningful upside to 2013 projected growth of 4.3%. That upside comes from five (apparently not everything comes in three) factors. First, consumers are in an upgrade cycle, having spent 1.9% more per pet product unit in 2012 and 2011.  If consumers continue to upgrade, or the impetus to upgrade expands to a broader segment of pet owners, revenues will increase faster than anticipated. Second, convenience is on the rise. Products and services are becoming increasingly available and operating frameworks are evolving to enable manufacturers broader reach. If access accelerates at a faster pace, revenues growth will benefit. Third, non-health service offerings continue to improve in both concept and delivery.  If disposable income continues to rise, or rises faster than anticipated, for core pet consumers, service revenues will benefit due to their discretionary nature. Fourth, the potential for the wellness theme to converge across product and service is improving through the continuing investment in information services. Information has the ability to ease the tension between owner and health provider. If platform adoption/usage accelerates faster than anticipated that will be good for veterinary clinic utilization.  Finally, capital continues to target the industry for above market returns.  Professionalization of the industry is good for growth.  If private placement volume accelerates industry performance will benefit.

As always, a full copy of my industry report is available by email.

/b