CircleUp Insights: Investing in the Pet industry

This week I was at the Global Pet Expo in Orlando, FL, the pet industry’s largest trade show each year with seven thousand attendees. The buzz at the show, and the performance of the companies he talked with, continued to reflect the strong growth of the industry. In particular, alternative format dog food companies are seeing incredible growth. As consumers focus on natural materials and innovative ways to keep pets entertained, many dog toy companies are also seeing increased attention- just like the premium pet market.

For those that haven’t been watching, the premium pet market has taken off in recent years. Pet expenditures in the U.S. have grown 5.7% annually since 2006, exceeding $50 billion in 2011 (APPMA – Pet Industry Stats). As highlighted in last Tuesday’s New York Times, the premium segment of the pet industry has driven a significant portion of industry growth (NYTimes – Pet Foods Go Gourmet). According to Packaged Facts, in 2009, 52% of pet industry spending was done by households with incomes greater than $70,000, up from only 36% in 1999.

The “premiumization” of pet is reflected by the torrid pace of M&A activity in the industry. Over the last few years, premium brands such as Natura, Merrick, Natural Balance, Zuke’s, Dogswell, Champion Petfoods (Orijen and Acana brands), Nature’s Variety and FURminator have received investments from strategics and private equity firms – providing healthy exits to earlier investors in the process.

So what are the pet industry trends that early stage investors should care about?

Not your parents’ dog food

After the pet food recalls of 2007, sales in the premium pet food category picked up, with natural pet food sales in tracked channels growing from under $700 million in 2005 to over $1.5 billion in 2009. Natural brands such as Innova, Natural Balance and Merrick that use real ingredients were some of the early beneficiaries. Next, the grain-free / high protein pet food movement caught on, and new brands like Orijen and grain-free versions of EVO, Blue Buffalo and others thrived.

While grain free kibble and natural pet food more broadly are still very attractive categories to be in, today, the raw/frozen/freeze-dried/dehydrated pet food movement is hot as well. Brands such as Nature’s Variety, Primal, Stella & Chewy’s, Bravo, The Honest Kitchen and a host of smaller players will be the beneficiaries of this trend.

Functional

In the pet treats segment, functional products, such as those designed to target pets with weight, joint, skin, anxiety and other conditions are thriving. With pets living longer, this trend should not abate any time soon. As an investor, when you are evaluating small pet treat brands, be sure to ask yourself if the brand is truly differentiated in terms of functionality. While a treat brand does not have to be functional to succeed today, if the brand is not differentiated on some metric (e.g. unique source of treat protein, unique delivery method), it is less likely to succeed in today’s hyper-competitive treat market.

The independent channel

While pet products are sold in many retailers, independent pet stores are typically where the premium pet brands that strategics and private equity firms covet launch. Because the channel is fragmented among so many “mom and pop” players, small brands can service a handful of stores without the working capital that selling to a 1,000+ store chain like PetSmart would require.

Additionally, these stores are more willing to take on the risk of an unproven product because their purchase quantities are so small. These independent stores can provide valuable proof of concept for younger brands, before scaling to Petco, PetSmart and other retailers.

Toys & accessories

Finally, keep an eye out for success stories in other premium categories, particularly toys and grooming-related accessories. An important determinant of pet toy success is if the toys are interactive and provide a function beyond simple chewing. Toys like KONG and Chuckit!, which engage pets in hunting for food and fetching, respectively, have had great success, but basic stuffed animal toys are hard to differentiate.

On the accessories side, FURminator, an innovative grooming tools company, grew revenue from $4.2 million in 2005 to ~$40 million when it was acquired by Spectrum Brands for $140 million in December 2011. Similar to toys, investors should look for accessory companies with unique technologies that solve pet parents’ problems. FURminator’s deshedding tools use patented technology to remove a pet’s loose undercoat while Bamboo, a grooming/toys company acquired last year by private equity backed Petmate, sells a nail trimmer that delivers an innovative solution to safely cutting pets nails.

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