The novel coronavirus pandemic has shifted consumer focus to healthy living and stress reduction. One way to pursue a healthy lifestyle is having pets. According to the American Pet Product Association (APPA), pets can “reduce our stress, lower our blood pressure, and can even help us live longer.” The APPA is working on educating the public on how pets can be beneficial to their health. It, therefore, seems like a good time to consider exposure to some pet stocks.
As a matter of fact, the pet industry has witnessed sustained growth. In fiscal year 2018, the U.S. pet industry expenditure was $90.5 billion. Expenditure accelerated to $97.1 billion in FY2019 and further to $103.6 billion last year. Pet food was the largest in terms of expenditure followed by vet care and product sales. These segments are likely to be attractive for exposure to pet stocks.
For the current year, the overall industry growth is expected at 5.8% to $109.6 billion. Clearly, the industry seems to be on a steady growth path and this is good news for companies in the sector. It’s also worth noting that the historical average growth rate for the pet industry has been 3% to 4%. With above historical average growth likely in the year, pet stocks are likely to be out-performers.
In terms of a bigger addressable market, the global pet care market size was valued at $232.3 billion last year. Between the current year and FY2027, the market size is expected to expand at a CAGR of 6.1%.
Considering these facts and growth outlook, some exposure to pet stocks can be considered.
Let’s talk about seven interesting names from pet stocks that are worth holding in the portfolio:
- Northern Star Acquisition (NYSE:STIC)
- Petco Health and Wellness (NASDAQ:WOOF)
- Trupanion (NASDAQ:TRUP)
- PetMed Express (NASDAQ:PETS)
- Chewy (NYSE:CHWY)
- Freshpet (NASDAQ:FRPT)
- Elanco Animal Health (NYSE:ELAN)
Pet Stocks to Buy: Northern Star Acquisition (STIC)
Let’s first talk about a pet stock that’s possibly flying under the radar and looks attractive. In December 2020, Northern Star announced a business combination with BarkBox. The transaction values BarkBox at an enterprise value of $1.6 billion.
As an overview, the company is a global omni-channel brand for dogs. The company caters to the sub-segments of fun, food, home and health for dogs. The company’s business model is subscription based and as of FY2020, active subscriptions were 663,000.
One reason to be bullish on BarkBox is the company’s high growth guidance. For the year, the company expects subscriptions to increase to 1.1 million. Further, the company expects net revenue of $369 million, which would imply year-over-year revenue growth of 64%.
Entry into new innovative segments is another key growth driver for the company. Last year, the company launched Bark Bright, which is a proprietary dog dental solution. The company also intends to use the brand as a future health and wellness platform. In FY2020, the company also launched Bark Eats, which is a personalized healthy food blends and service.
Given the strong growth in subscriptions and innovative solutions, BarkBox is positioned for strong top-line growth. The company expects revenue to accelerate to $706 million by FY2023.
After touching highs of $19.50, STIC stock has declined to $11.6. I believe that these are attractive levels for exposure to the stock.
Petco Health and Wellness (WOOF)
WOOF stock listed in January at $29.40. The stock has been sideways to lower and currently trades at $22.3. At a forward price-to-earnings-ratio of 32.9x, WOOF stock looks attractive among pet stocks.
As an overview, Petco is an integrated health and wellness company for pets. As of December 2020, the company had 1,454 pet care centers and 125 full-service vet hospitals. In addition, the company had 96 pet care centers in Mexico.
For FY2020, the company reported revenue of $4.9 billion and an adjusted EBITDA of $484 million. With the initial public offering, the company expects to reduce leverage from 7.4x to 3.2x. This is likely to have a positive impact on profitability. For the last year, Petco Health also reported free cash flow of $109 million. Growth in operation cash flow and FCF is one of the key valuation upside triggers.
It’s worth noting that the company’s omni-channel and digital sales platform is likely to accelerate long-term revenue growth. As an example, the company’s digital platform reported 100% growth. This growth was triggered by services like buy online and pick-up at store and same day deliveries.
I believe that WOOF stock might have bottomed out. The stock is likely to trend higher if profitability growth is robust coupled with a steady increase in operating cash flows.
Trupanion is a unique play in among companies providing service for pets. After touching a high of $126.5, TRUP stock has corrected to $75.6. The stock is still higher by 148% over a one-year period. Current levels look attractive for fresh exposure.
As an overview, Trupanion provides medical insurance for cats and dogs on a monthly subscription basis. For FY2020, the company reported revenue of $502 million, an increase of 31% on a YOY basis. It’s seems very likely that strong revenue growth will sustain in the coming years.
A key reason for this view is massive market under-penetration. To put things into perspective, the percentage of pets with insurance is 40% in Sweden and 25% in the U.K. However, it’s just 1% in the United States and approximately 2% in Canada. Clearly, there is significant scope for revenue growth.
It’s also worth mentioning that the company’s subscription-based revenue was $387.7 million in FY2020. With more pets getting enrolled, recurring revenue is likely to be significant in the coming years. Trupanion seems to be well positioned for health free cash flows. The company also has an average monthly retention of 98.71%. A high retention rate would imply sustained upside in recurring revenues. Therefore, TRUP is among the attractive pet stocks to consider for the long-term.
PetMed Express (PETS)
PETS stock seems to be among the undervalued names in the industry. The stock currently trades at a forward P/E of 20.6x and also offers an attractive dividend yield of 3.4%.
PetMed Express is a leading pure play online pet pharmacy. The company has more than 2.3 million unique customers who have purchased in the last two years. With licensed pharmacy for all 50 states, the company has a strong market position.
For the first nine months of the current financial year, the company reported revenue of $238 million. This implies an annualized revenue of $317 million. The important point here is that the company believes that the industry size is $6 billion. A 10% market share in the coming years would imply nearly doubling of revenue to $600 million.
Further, PetMed already has an annualized operating cash flow of $30 million. I would not be surprised if OCF is around $100 million with doubling of revenue. At a market capitalization of $665 million, the stock does look attractive.
From the perspective of accelerating growth, the company is looking at expanding the line of pet medications. In addition, the company is expanding digital sales. These efforts are likely to translate into healthy revenue and cash flow growth.
CHWY stock seems unattractive from a valuation perspective. However, the stock is worth accumulating on declines. The company is a pure play in the e-commerce business for providing pet food, supplies, medication, among others.
For FY2020, Chewy reported sales of $7.15 billion, which was higher by 47% on a YOY basis. Sales growth has been robust and the company has 19.2 million active customers.
However, the markets would re-rate the stock if adjusted EBITDA margin expands. For FY2020, the company reported adjusted EBITDA margin of 1.2%. However, for Q4 2020, the adjusted EBITDA margin was 3%. It seems that sustained margin expansion is on the cards as active customers grow along with growth in net sales per active customer.
It’s worth noting that Chewy competes in 70% of the $100 billion U.S. pet market. With the market size likely to expand to $120 billion by FY2024, there is an opportunity for sustained growth. Further, with the pandemic, e-commerce penetration has accelerated and Chewy is well positioned to benefit from this trend.
For the current year, the company has guided for 24% to 25% sales growth. Further, EBITDA margin expansion is likely at 50 to 100 basis points. However, even with strong growth, the stock looks expensive at a forward P/E of 2,789x. Once there is significant expansion in key margins, the stock will start looking attractive.
FRPT stock has been in a steady uptrend with returns of 158% in the last one-year. At a forward P/E of 462x, valuation might be a concern. But the company is attractive if you consider it on corrections.
Freshpet is a provider of fresh food for dogs and cats, which includes meats and vegetables. The company’s offering is available through grocery stores and specialty retailers in the United States, Canada and Europe.
High-quality food for pets is a key differentiating factor for the company. Freshpet claims that 82% of consumers notice a visible health difference when their pets are provided with the company’s food offering.
The company reported sales of $318.8 million for FY2020, which was higher by 30% on a YOY basis. However, e-commerce sales growth were 173% higher and for Q4 2020, online sales accounted for 6.1% of net sales. Having omni-channel capability will allow the company to push for higher revenue growth.
It’s also worth noting that for FY2020 revenue growth was 30%, but adjusted EBITDA growth was 61%. With economies of scale, the company is likely to deliver robust EBITDA and cash flows in the coming years. To put things into perspective, the company has a FY2025 target of $1.25 billion in revenue and $312.5 million in adjusted EBITDA. The company also expects strong free cash flow from FY2023 and beyond.
With these estimates, FRPT stock is among the top pet stocks to consider. However, it makes sense to wait for some correction.
Elanco Animal Health (ELAN)
Elanco is another company that’s focused on animal health. The company has a global footprint with pet health being the largest revenue contributor. ELAN stock currently trades at $30 and has trended higher by 34% in the last one-year. At a forward P/E of 30x, the stock looks attractive.
A key reason to be bullish on Elanco is a robust product pipeline. For the current year, the company expects to launch eight products. This is likely to contribute $80 to $100 million in incremental revenue.
For the current year, the company expects revenue in the range of $4.5 billion to $4.6 billion. Further, EBITDA margin is expected in the range of 21% to 22%. As margins improve and cash flows increase, the company is targeting net leverage to be below 3x by FY2023. This is likely to have a positive impact on profitability.
Overall, Elanco looks attractive with a diversified product offering, global presence and new product launches. Morgan Stanley is overweight on ELAN stock with a price target of $41. This would imply an upside of 36% from current levels.
On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.