skyThe pet industry continues to work through a series of fundamental issues — demographics, channel shift, brand attributes — that, over time, are expected to reshape the competitive landscape.  While fundamentals are favorable — consumption, consumer confidence, employment, real wages, housing — these tailwinds are not sufficient to float all boats.  When the market bifurcates into “leader” vs. “laggard”, and the historical leaders now find themselves playing catch-up, you get dynamic market shifts.  While there are signs of a transition in process, this cycle is only now gaining momentum, and inertia will take some time.  In the interim, here are the key trends we are keeping an eye on over the forward six months:

  • Growth On Pace for Anticipated Uptick.  The pet industry experienced a relative malaise in 2015, with industry growth, as measured by APPA figures, slowing to 3.8%, despite a 0.3% uptick in performance of the food category, the largest component of pet spend (~38%), to 3.5%. Based on macro indications the industry appears on pace to exceed projected 2016 growth of 4.3%, driven by an acceleration in consumables.  That said, a rising tide is not lifting all boats. Growth is manifesting itself in a much more pronounced way, from a percentage standpoint, among independent retailers and brands, from brands that have managed the digital migration of their message and products effectively, and from brands that rely on or incorporate alternative form factors. Growth, in isolation, masks a myriad of problems. Large retailers and major pet food marketers risk further erosion of their franchises if they don’t adapt more quickly to emerging ownership and channel realities.
  • Industry Working Through Transitionary State. The foundation of our Spring 2016 report was the observation that the industry was undergoing a restructuring, and would remain that way throughout 2017. This restructuring involves tactical changes to embrace evolving ownership demographics and consumer behavior patterns. We are seeing signs that many key players are in fact moving to action. A number of larger manufacturers are actively working through their digital strategies and assessing how they develop both ecommerce and customer analytics capabilities. Mid-sized box chains and distributors are evaluating alternatives for addressing online gaps. Several key pet specialty brands appear poised to move to FDM. Finally, online retailers and large distributors seem to be headed towards a convergence. While not all the key transitory events identified are in play, the industry is shifting before our eyes. These changes should drive increased M&A activity.
  • Small Box World is Consolidating.  The rise of the independent pet channel has been one of the greatest value creators for the pet industry post-recession. Growth in small box and mid-sized chains has paid significant dividends for the brands that cater to them, the distributors that serve them, and the owners of the most professionalized operations. This channel is viewed as the champion of the consumer, providing them with education and advice and, as a result, has attracted a slew of authentic brands seeking to monetize this connection. Now the channel is consolidating. While acquisitions by Tractor Supply, Pet Supplies Plus, and Pet Valu are most notable, so to is the external communication from companies like Chuck & Don’s and Bentley’s Pet Stuff that they are seeking acquisition opportunities. Many chains will have to choose whether to participate in this race for scale and geographic expansion, or temper their growth expectations.  Long term, omnicannel will win in both broader retail and pet.  However, to develop these capabilities a certain scale is required in order to justify the investment.
  • Deal Volume Increases but Not Realized Outcomes. When industries undergo evolution, transaction velocity predictably increases as companies try to reposition themselves for the next growth cycle. This phase began in 2H2014 when pet industry M&A activity spiked and continued through the record year of 2015.  While we continue to see elevated levels of market activity in 2016, it has yet to translate into a pace of closed deals that would match the prior year period, making it likely 2016 will be a down year for closed deals.  The reasons for this are multi-faceted. First, when large strategic buyers are working through their own portfolio issues they tend to prioritize their current brands at the expense of M&A. Second, as buyers step further out of their comfort zone, they tend to be more price sensitive. Finally, a number of buyers continue to digest their acquisitions from 2015, making them less aggressive on the M&A front. Couple this with continued high valuation expectations on the part of lower middle market sellers and you end up with more failed sale processes.

As always, a complete copy of our 2H2016 industry report is available by email.

/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.

phoenisThe 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.

/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.