Add Pet Companies To Diversify Your Portfolio

Includes: FRPT, IDXX, PAWZ
by: Exorior

68% of US households own a pet.

30% growth in US sales over the past 5 years.

Industry kept growing during the great recession.

Consumer staples incorporate products that are deemed essential to many people. Such products include food, drugs, or household goods. Some of the products described as consumer staples are not necessarily mandatory but they can be products that consumers are unwilling to forgo.

These goods are in demand regardless of the broader economy and can provide a resilient market exposure during a downturn.

Focusing on the US, it is clear that pets are mainstream. The ownership number is growing steadily and the annual pet expenses are on the rise.

Is it time to add the defensive pets industry to your portfolio?

The industry in general:

The total US pet industry expenditures have been growing every single year over the past 20 years according to the American Pet Products Association (APPA).

The 2019 US expenditures are expected to reach $75bn, an increase of $17bn (30%) over the past 5 years.

As shown in the graph below, even during the 2008-2013 recession, pet expenditures kept growing at an average pace of 5% per year. Whilst many households were tightening their budgets, pet expenditures kept climbing and the industry showed strong resilience despite the recession.

According to the 2017-2018 national pet owner survey conducted by APPA, 68% of US households own a pet. The number of dogs kept as pets in the US has increased by approximately 50% between 1988 and 2017.

Whilst the ownership grew, the products offering also grew with a wide range of goods and services now available to pet owners. Various technology and gadgets products have surfaced whilst on the services side, owners can now treat their animals to massage, spa therapies, and funeral services.

Whilst some more luxurious expenditures (spas, technology) may suffer during a downturn, staple segments such as food and healthcare services are unlikely to go down. Pets are often seen as members of the family and owners' commitments would maintain demand for goods and services seen as essential.

A BLS consumer expenditures survey conducted in 2011 showed that on average, each US household spent $500 on pets. In 2011, households spent more on their pet than on their phone bills, men and boy clothing or alcohol. The survey also showed that spending on pet food remained constant or increased during the 2008-2013 recession whilst money spent on restaurant went down.

Within the industry, pet healthcare is probably the most defensive segment. Whilst premium expenses could be restricted if households budgets come under pressure, it is unlikely that people will skip the veterinary appointment when their dog gets sick. The ownership trend has been beneficial to the more traditional segments like veterinary services. According to the Bureau of Labor Statistics (BLS) in its job outlook studies, veterinary occupations are expected to grow by about 19% during the decade to 2026 compared to 7% average for all occupations. In the meantime, the life expectancy of pets has gone up. This translates into an ageing pet population and provides good prospects for the pet healthcare sector.

How to add exposure to your portfolio?

Investors looking for direct stock exposure can look into the following companies.

Freshpet (FRPT) is a manufacturer of fresh, refrigerated food, and treatment for dogs and cats. Their products are distributed in 19,000 stores across the US. They pay no dividends but shares have performed well, being up 55% over one year. They were among the first to operate on the fresh, refrigerated food niche. With a strong growing demand for fresh and healthier human food, stretching this well being approach to our four leg friends seems to be an inevitable step. This should provide good business prospects for Freshpet. According to a Nielsen study, fresh pet food sales in US grocery stores jumped 70% between 2015 and 2018. Freshpet annual sales have more than doubled between 2014 and 2018. The 2019 guidance, with sales of $240m, would be an increase of approximately 24% compared to 2018. Although the company has reported net losses over the past few years, the growth momentum remains impressive. The balance sheet is healthy but current valuations are high with a price to book ratio of 13x and the absence of profits. This would not be of interest to value investors. Nonetheless, the company presents an interesting way to gain exposure to this fast growing pet food segment and stands to benefit from the upward trend.

Chart Data by YCharts

Another interesting name is Idexx Laboratories (IDXX). It is a global player providing diagnostics products and services to veterinary practices. This is a large company with over $24bn market capitalisation and over $2bn revenue. Shares are up 20% over one year. The pet health care segment is a strong, resilient component of the pet industry. Health treatments are fairly immune to an overall downturn as owners remain committed to their pets, often seen as members of the family. In addition, life expectancy for pets has increased. This creates an ageing pet population which requires more health services. Although its industry is showing strong prospects, current valuations are lofty with P/E ratio of 63x, and a P/B of 470x. Annual sales have increased steadily between 2014 and 2018, going up 49%. 2019 full-year guidance of $2.4bn would represent a 8.5% increase compared to 2018. Valuations are high and it does not seem to be a good buy opportunity at present. The year on year growth, although decent, does not seem to be strong enough to justify current valuations. Investors would need to remain cautious, but this is a name worth monitoring.

Investing into a pet ETF could be an easier way for investors to gain a broad exposure without cherrypicking. Pet industry ETFs are not widespread but investors looking for a simple way to add pet exposure to their portfolio can look into ProShares Pet Care ETF (PAWZ). The ETF picks companies that are likely to benefit from a growing pet industry. The ETF which debuted late last year has a YTD (as of end of July 2019) performance of about 18.6%. Some of the holdings include direct play companies such as Chewy (CHWY) and Pets at Home Group plc (OTC:PAHGF). Pets at Home Group plc is the UK's largest pet supplies retailer. The company operates about 370 stores. Interestingly, the company also provides pet care via its nationwide network, thus benefiting from different segments of the pet industry. The company pays a 3.6% dividend yield and generates about £1bn revenues. The shares are up 75% over one year. The 1.1x P/B ratio is more reasonable than other shares mentioned in this article whilst the P/E stands at 34x. Other holdings in the ETF include large groups like Nestle (OTCPK:NSRGY) with food brands Felix and Friskies. The ETF is an attractive opportunity to add the pet sector in a portfolio.

Disclosure: I am/we are long FRPT. 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.