It took a moment, but investors figured out that pet stocks should be a beneficiary of the novel coronavirus pandemic.
Indeed, the ProShares Pet Care ETF (BATS:PAWZ) has rallied 35% so far this year. It’s soared 91% from March lows. The gains make some sense.
After all, amid “stay at home” orders, pet adoption increased worldwide. In fact, many U.S. animal shelters were emptied. But the industry has more than just a short-term tailwind behind it.
Pet ownership has been growing for years. But, importantly, so has spending per pet. The “humanization” of pets, as pet food manufacturer Blue Buffalo memorably termed it, has been going on for years. Each year, pets get better food, better medicine, and improved veterinary care. Pet spending didn’t decline even during the Great Recession.
As a result, major investors have targeted the industry. Blue Buffalo was acquired by General Mills (NYSE:GIS) as part of a bid to pivot away from less attractive markets like cereal and yogurt. German conglomerate JAB built out a massive coffee business before turning its eyes to pet care.
Pure-play pet stocks have rallied as well. But given the combination of long-term growth and the industry’s defensiveness, the rallies can and probably should continue. These four pet stocks look particularly attractive, with bull cases that can attract any kind of investor:
Pet Stocks: Zoetis (ZTS)
The simplest, “set it and forget it” play among pet stocks might be Zoetis. The company develops and manufactures medicines, vaccines and diagnostic equipment for animal health.
It’s been a booming business, and that has made ZTS stock a winner. Shares have rallied 429% since the company was spun off from Pfizer (NYSE:PFE) back in 2013. There’s little reason to believe that growth will slow. Again, veterinary care spending continues to rise. Zoetis is the clear industry leader, with close to 20% market share worldwide. Investors who are bullish on pet stocks as a whole should see ZTS as highly attractive.
But there are two concerns. The first is valuation. ZTS stock trades at a whopping 39x forward earnings. Granted, analysts are looking for 15% profit growth next year, but it’s fair to wonder if a good chunk of the good news is priced in. Indeed, the average Wall Street target of $173 at this point suggests just 6% upside over the next year (plus a 0.5% dividend yield).
The second is that Zoetis isn’t just a pet play. It also has a large livestock health business, which accounted for almost half of 2019 sales. That side of the business has more challenges in front of it, between pressured farm income in the U.S. and environmental concerns about production.
Still, there’s a lot to like here, and ZTS has rallied through similar concerns over the last couple of years. Investors might want to hope for a pullback, but the simple bull case for Zoetis stock still looks attractive.
Chewy is very much in the eye of the beholder. To skeptics, CHWY stock is a disaster waiting to happen. Last year, well-known investor David Einhorn compared the company to infamous dot-com bust Pets.com. Revenue growth has been phenomenal, but skeptics argue that the company’s lack of profitability highlights the problem with its strategy.
Chewy is barely profitable even on an Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) basis. To bears like Einhorn, that proves that shipping bulky pet food at thin margins is not a business that can truly create earnings.
Revenue growth is impressive, yes, but Chewy basically is selling dollar bills for 98 (or 95) cents. And if there are profits to be made, presumably the likes of Amazon (NASDAQ:AMZN) and Walmart (NYSE:WMT) can and will muscle the company out.
I’m far more optimistic, however, at least as far as the business goes. I’ve been a bull on CHWY stock since its initial public offering last year. Near-term spending on customer acquisition is driving the lack of profitability. That problem will be ameliorated over time. Those acquired customers become profitable in a hurry, and continue to increase their spend over time. (My household certainly fits that pattern.)
As for competition, it will be intense. But well-run niche retailers continue to thrive online. Wayfair (NYSE:W) and Etsy (NASDAQ:ETSY), too, were presumed roadkill for the two giants. Both have thrived — though Wayfair faces questions about its profit margins.
But, as with ZTS, valuation is a concern. Chewy now has a market capitalization of $24 billion. It sold itself to Petsmart for just $3.35 billion only three and a half years ago. Indeed, I exited my position near current levels earlier this year due largely to valuation worries. And even a blowout earnings report couldn’t keep CHWY from dipping last month.
Still, valuation hasn’t been a reason to sell in this market. And Chewy has the potential to enter new markets (including pet care) and new geographies. There’s a lot to like here, particularly for more aggressive growth-focused investors.
PetMed Express (PETS)
On the other side of the coin is PetMed Express, which might be the cheapest of all the pet stocks at this point. PETS stock trades at just 18x forward earnings, and closer to 16x when backing out cash on the balance sheet. Income investors will find a 3.7% dividend yield attractive as well.
Both metrics, however, show the risk perceived by the market. So does a hefty short interest of 30%. Bears worry that competitors will steadily erode PetMed Express’s online pharmacy business. Those competitors include Chewy, which is investing heavily behind its own pharmacy effort. Those larger rivals have entrenched customer bases and significant amounts of cash. That will allow them to compete on both price and convenience. At some point, PetMed Express presumably won’t be able to keep pace.
That said, the company has done reasonably well so far in 2020. After earnings started heading the wrong direction last year, PetMed Express righted the ship. Customer acquisition exploded during the pandemic, which reversed top- and bottom-line declines. Minimum pricing requirements from manufacturers like Zoetis should mitigate competitive factors somewhat.
Again, PETS is not without risk. But at this valuation, the company doesn’t need to grow like Chewy; it simply has to hold its own. At least so far in 2020, it’s doing so.
Freshpet has been one of the best pet stocks of the last few years. In fact, it’s been one of the best stocks, period. FRPT stock has gained 624% over the past three years, and more than 1,000% over the past five.
Unsurprisingly after that kind of rally, Freshpet stock has a nosebleed valuation. It trades for roughly 227x 2021 EPS estimates. But, in this market, stocks that have soared to seemingly unsustainable multiples generally have kept gaining. And despite the headline figures, there’s a case that FRPT can keep going.
After that rally, the company still has a market capitalization under $5 billion. Blue Buffalo, which at the time focused mostly on dry dog food, sold for $8 billion. Freshpet’s niche and higher-priced products ostensibly could garner that kind of number at some point.
Meanwhile, the business focuses on the strongest tailwind behind pet stocks: the increasing number of customers willing to spend up to pamper their pets. With nationwide distribution finalized and room for expansion, FRPT can ride that tailwind to more gains, even if expecting another 1,000% rally might be too optimistic.
After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets. On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.