If you have been paying attention over the last few weeks, you will be aware that U.S. consumers are in pretty good shape. There has been a succession of good earnings reports from retailers, including Macy’s (M) and Kohl's (KSS) this morning, both offering beats all around and strong Q4 guidance. The problem for investors at this point is that this is old news. It has been evident for some time that consumers are spending and, as a result, stocks in retail are in many cases already priced to perfection. Macy’s, for example, has gained around 300% in the last year.
That leaves us looking for areas that can benefit from healthy consumer spending, but which aren’t pushing at the highs. One answer may be pet care.
According to the American Pet Products Association, around 85 million U.S. families owned one or more pets in 2020. That year also saw the money that we spent on our pets exceed $100 billion for the first time. It was presumably boosted by the number of people who adopted a pet during the pandemic but based on the numbers so far, it is expected to grow again in 2021. It stands to reason that if consumers are spending more on themselves, they will also spend more on their animals, so even optimistic estimates for that number may be too low.
Obviously, pet care is a massive and growing market, but there is a slight problem for investors who want to enter that space. Some of the biggest players in that market are huge conglomerates, where pet care represents only a small percentage of their business. That would include companies like Merck (MRK), which is in veterinary services, or Colgate Palmolive (CL) in pet nutrition. If you are to take advantage of pet owners flush with cash, you are looking for more of a pure play and for companies that offer premium or somewhat more frivolous products.
That brings in purveyors of pet beds, toys, and other non-essentials, such as Petco (WOOF). Petco announced earnings this morning too and, like other conventional retailers, they came up with the trifecta, beating on both top and bottom lines, while raising forward guidance. Initially, the stock jumped on that, but as it became clear that the supply chain issues we have all heard about could make things more difficult in the coming months, it fell back and now looks like opening the day lower as I write this.
That may squeeze already tight margins at Petco, but this is a growth story and at just under 1.4 times sales, the stock looks decently priced at these levels. If the basic premise here is correct and consumers are prepared and able to spend more on their pets, those margins will improve as sales grow, so WOOF would benefit on two fronts.
The same story of tight margins also applies to my other single-stock pick in the space, Freshpet (FRPT). They are actually operating at a loss right now, but the need for refrigeration of their ultra-premium, fresh pet foods means that their distribution costs are front-loaded. Once the initial costs of supplying retailers with refrigerators are gone, however, margins will improve, and FRPT should be able to swing to a profit.
If those are too risky for you and the case for them contains too many assumptions, you could consider something that could take advantage of increased spending on pets in a broader sense, such as the ProShares Pet Care ETF (PAWZ). The fund counts both WOOF and FRPT in its top ten holdings, but also veterinary medicine companies like Dechra Pharma (DPH) and Zoetis (ZTS) and other less-focused plays such as the aforementioned Merck and Nestle (NESRGY).
Whichever way you play it though, pet ownership, and therefore spending on pet products, has grown rapidly over the last few years and looks like continuing to do so as owners have more disposable cash to spend on their furry friends. And yet, many stocks in the industry are below their highs. That is an opportunity, and even if you are not a pet owner yourself, it may be a way for our furry friends to bring you some joy too.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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