There is no doubt Blue Buffalo (BUFF) stock is expensive, but considering the solid position enjoyed by the company in the 'healthy' pet food category, decent organic growth, relative underrepresentation in various distribution channels, good execution on the profitability front and a heavy load of skepticism in the investor base seem to suggest that this might not be the best time to short, rather a good opportunity to take a closer look and monetize the positive catalysts combined with good visibility, a rarity in the retail land right now.
Besides being expensive on historical financial metrics, the stock performance has also been marred by concerns related to the ingredients controversy, raised by the 900-pound gorilla in the pet food space - Nestle S.A. (OTCPK:NSRGY) via Purina, issues that may remind investors of the early years of the organic food wave. After the weak performance of Freshpet Inc. (NASDAQ:FRPT), increasing popularity and the resultant increase in competition has also invited increased scrutiny for the natural pet food space in general, even though hardly anyone doubts the strong industry trends anymore.
Of course, how the economy will perform continues to be an open debate, but given the spending on pets in the U. S. has grown every year since 1994, the sector, especially if the trends seen in the previous slowdown hold, may even offer one of the sweet spots within an uncertain retail environment.
Strong and well differentiated market position
The company has done a great job in creating a niche in the 'natural' pet food space, a market that is growing consistently, yet largely dominated by less than half a dozen players offering limited differentiation. One cannot say the same thing about that many other retail stories. The result is good scale, decent growth and strong margins.
In a market environment, where consumer names are disappointing, e.g. Whole Foods (NASDAQ:WFM) results yesterday, the industry is enjoying extremely favorable tailwinds - pet ownership is rising and there is a shift towards customers going for premium products for their pets, which is resulting in decent pricing power to brands like Blue Buffalo. Indeed, the average price per pound of pet food has grown by more than 40% since 2011. No wonder, the pet food space is expected to continue to grow around a low single-digit rate and the premium cat and food within the space at a much faster rate of 10-15%.
Image source: Petfood Industry
As one of the fastest growing major pet food companies in the U. S. with a top brand in the Natural market segment and approximately 6% market share of the overall pet food industry, the company should be high on the list of potential acquisition candidates for players like J.M. Smucker (NYSE:SJM) and Mars Inc., which are increasing their presence in the space through acquisitions. For the stock, the option may offer a decent floor.
Reasons to look forward to and cheer in the near-term
Topline growth has been decent, with contribution from improving volume, pricing and product mix, and going forward broader geographic expansion and expanding channel presence should help the company maintain the expected growth momentum that suggests market share gains.
In terms of distribution channels, even though the growth of pet superstores is muted, the company's relatively strong position in e-commerce, neighborhood pet stores and farm & feed channels, which are relatively underpenetrated, should position the company well for relative outperformance. In the meantime, new products like the diet product line, Bayou Blend and Denali Dinner are just expanding.
Geographically, the business is just getting started on the international expansion front, with spending on infrastructure and distribution underway and expectation of revenue contribution by 2017 onwards.
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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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