I follow Warren Buffet’s advice whenever possible. One bit of advice from Mr. Buffet is to invest in companies you can understand. The pet care industry is easy to understand. The number of households with pets and the total number of pets are increasing. Seventy percent of American households, 90.5M, have pets. This is up from 57% in 2016. This accompanies the societal trend of increasing pet humanization. People spend an increasing amount of money on fancy foods, treats, clothes and accessories (yeah, that’s really an official category), medical care, grooming, insurance, daycare, and walking. These trends converge to create exceptional, easy to grasp investment opportunities. Here are some companies that I’m following.
In 2020, people spent an average of $1200 on dog care and $687 on cat care. The highest expenditures were on food followed by veterinary care. Freshpet (FRPT) sells refrigerated dog and cat food. I don’t own this stock. I find this company hard to get into. Where is the competitive advantage of feeding human food to dogs? How hard could it be for Costco, Walmart, Purina, or god-forbid pet owners to steam (the Freshpet method) some chicken and stuff it in a plastic tube? Their advantage seems to be branding. They have installed branded refrigerator cases in hundreds of stores which keeps their brand in front of customers and provides easy access.
I still don’t get it though. And, despite the extensive sustainability efforts of the company, I have a problem growing animals and catching fish for pet food. There are actual people without ‘human quality food’. Pets can be sustained on animal scraps ground into kibble. The stock appreciated rapidly during the pandemic but is down 30% since May.
Chewy is an e-commerce company that sells everything for pets. I love e-commerce. Some of my best performing stocks are Etsy (ETSY), Amazon (AMZN), and Sea Limited (SEA) but I have never been convinced to invest in Chewy. Chewy benefited from the pandemic when it was difficult or risky to go out for pet food. In 2020, Chewy grew active customers and sales by over 42%. Sixty-eight percent of sales are from autoship customers. This is good because there is no cost for Chewy to acquire the autoship sales and inertia keeps customers from stopping them. If you haven't seen Chewy boxes sitting on half the porches in your neighborhood, you need to walk more.
My problems with Chewy are that their profit margins are low and capital expenditures are high. Unlike Etsy, for instance, which has a gross margin over 70%, Chewy’s gross margin is around 27%. The reason is that Etsy is a platform that facilitates e-commerce. Chewy is a merchant that buys and holds inventory, builds warehouses, and needs a lot of labor. Chew employs 18,500 people to generate $7.66B in revenue ($41,405/employee). Etsy employs 800 people to generate $2.15B ($275,000/employee). Chewy is expanding the pet healthcare components of its business. These include Chewy Pharmacy, launched in 2018, custom compounding pharmacy, and best of all, a telehealth service called Connect with a Vet. These services could attract new customers and provide higher margins than shipping dog food. Chewy is down 37% from its recent high and is worth watching.
Trupanion (TRUP) is my favorite of the three we’ve covered so far. It provides pet health insurance which is the new thing pet owners must have. Based on their most recent investor presentation, 25% of pet owners have insurance in the UK and 40% in Sweden. In the US 1% of pet owners have insurance. Europe demonstrates the market exists and is huge. If the US reaches 2% insured pets, like Canada, the market will have doubled and Trupanion will be the biggest winner. The pet insurance industry grew 36% ($120M) from 2019-2020. Twenty-six percent of this growth went to Trupanion. There are other companies that offer pet insurance. Trupanion has advantages described in their shareholder letter based primarily on relationships with veterinarians and artificial intelligence.
Veterinarians and customers love Trupanion because they pay claims instantly. Other pet insurance companies require customers to pay the vet then file a claim in hopes of getting it covered. Trupanion pays vets directly within 5 minutes. Usually, the vet has been paid by the time you check out so you only pay your portion. It’s easy for everyone and encourages vets to promote Trupanion over other insurance. Trupanion also has relationships with veterinary industry leaders like Idexx Laboratories (IDXX) that collect data on every new animal that visits a vet and shunts those referrals to Trupanion.
Like Freshpet’s steamed chicken, how hard could it be for legacy insurers to offer pet insurance? It’s probably not hard but legacy insurers may decide it’s not worth the hassle. State Farm, for example, entered into an agreement to offer pet insurance through Trupanion rather than develop their own product. Others may follow suit. Overall, it seems Trupanion has a focus on their customers and veterinarians and making their lives easier and pets lives longer. Trupanion is down around 30% from its recent high which isn’t uncommon for a small-cap. Trupanion covers just over 1 million of the nation's 180 million dogs and cats so there is ample room for growth in this under-penetrated market.
IDEXX Laboratories (IDXX) and Zoetis (ZTS) are large-cap animal healthcare companies. They produce vaccines, pharmaceuticals, diagnostic testing, and veterinary consumables for pets and farm animals. The companies have similar revenue growth and profits. Investors are more excited about IDEXX because of its focus on pets and vets. IDEXX derives about 90% of revenue from its pet segment, the fastest growing market, compared to 55% for Zoetis. In addition, IDEXX offers a greater diversity of veterinary products including a software suite for veterinary practice management, diagnostic decision making, and other applications. Software is a high margin business and once a veterinary practice is using IDEXX software it is more likely to use its other products. IDEXX also offers veterinary imaging hardware, software, and consumables that Zoetis does not. Finally, IDEXX offers telemedicine and consulting for veterinarians who are using their products and software.
I own about twice as much IDEXX than Zoetis which is primarily due to its greater stock appreciation. After my research for this article though I like IDEXX better because of its focus on pet care and veterinary practices. I would add new money to my IDEXX position over Zoetis but they are both stable fast growing companies. Zoetis also has a 0.48% dividend yield. Both stocks are beating the market, though to very different degrees, so there is no reason not to include both as part of your pet care investment allocation.
I write these posts for fun and to learn more about investing. This should not be construed as stock advice or recommendations. I am an amateur who enjoys investing, research, and writing with no training in finance, stock analysis, or related fields. I may own stocks discussed.
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