The pet industry stands at the precipice of a tactical sea change. The industry entered into this transitional phase in 2014 and is expected to remain there through 2017. The industry entered into this state as a result of slowing growth and macroeconomic headwinds. The historical catalysts for growth — Baby Boomers as the driver of industry spend, pet food upgrade cycle, premise based retail — have waned. However, the future change drivers — pet ownership among Millennials, grain-free and alternative form factor pet food, ecommerce, connected pet — are individually not yet sufficient to resurface the landscape. Yet we expect, after another year of gestation, these trends, will set of the next phase of industry growth, market share shift, and strategic acquisitions.
As we muddle through the tail end of this transitional phased, here are trends we are keeping an eye on in 2016:
- Industry Offers More Upside Opportunity than Downside Risk. Despite the slowing sequential growth rate for the industry and the limited innovation in consumables, we believe the industry stands poised to outperform in 2016. Our premise relies on three factors. First, the acceleration in pet adoptions experienced in the 2H2015 will have a knock-on effect on pet spending in 2016 as these new owners generate a full year of expenditures and trade up to premium solutions. This adoption spike is consistent with the 2012 – 2013 period where growth was 4.5%, albeit from a smaller base. Second, while the pet food upgrade cycle may be running on fumes, a proliferation in food additives, convenience offerings, and premium cat solutions will provide the industry with a growth impetus. Finally, we view the macro economic stability for employment, wage growth, and consumer sentiment as remaining favorable through the balance of 2016.
- Expect Transaction Velocity to Remain High. 2015 was a return to normalized transaction velocity levels for the industry after a two year hiatus. We expect transaction velocity will remain high in 2016 as consolidation themes continue and sellers try to take advantage of the tail end of the capital markets cycle. What will change is the types of deals that are getting done. In 2014 and 2015, the industry was the subject of a large number of headline grabbing transactions involving key industry names – Big Heart Brands, PetSmart, Petco, MWI Veterinary Supply. Absent a sale of Champion Petfoods, we expect most of the velocity to be among companies valued at less than $250 million. Notably, the M&A rumor mill was at peak decibel levels at Global Pet Expo. However, the number of companies pursuing deals pursuant to organized processes appears lower, meaning the number of potential deals that could get done pursuant to one-off dialogs is elevated.
- Consumables Lines Blurring in New Ways. Five years ago, the thought of a pet treat business being able to bridge into pet food was unthinkable. Today there exist a myriad of treat brands which have developed a trusted connection with consumers in the pet specialty channel that might allow them to make that leap. Notably, several of these brands launched food solutions at Global Pet Expo to very favorable retailer response. While it is unclear if and how quickly these solutions can scale, it speaks to the fact that the delineation between food and treat brands continues to decrease. As premium pet food companies find market share gains harder to come by, we expect they will seek to expand sales volume through increased treat offerings and acquisitions of treat companies. Further, treat company valuations will benefit from buyers factoring in potential product line extensions into food, though not all brands will benefit.
- Ecommerce Landscape Changes Ahead. Sales of pet products continues to grow online fueled by price based competition and increased convenience. The impact of growing online sales can been seen acutely in the comps of Petco and PetSmart prior to their representative transactions. However, the pain has spread to the independent channel as well, as more brands have embraced ecommerce as a driver of growth and customer acquisition. In response, retailers are putting pressure on manufacturers to enforce MAP policies or, in some cases, choose sides. However, many of the brands caught in the battle among retail formats are not well equipped to do either. Assuming that Chewy.com continues to find fuel for its growth, and that Jet.com continues to find brands willing to embrace its platform, this problem will grow. Pressuring brands will not solve the problem. Rather, the winners in retail will be those who deliver the best consumer service experience as measured by selection, price, and convenience. Independent retailers will need to develop capabilities that enable their customers to shop online and get accelerated delivery, presenting an opportunity for distributors to fill this void.
As always, a complete copy of our 2016 industry report is available by email.
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.