During the pandemic lockdowns, adopting pets became popular, resulting in a whopping 5 million more pets being added to households in the U.S. Morgan Stanley predicts that the overall spending in the pet industry will grow at a compounded annual growth rate of 8% and will be worth $277 billion by 2030, reaching $1,320 per pet per household in 2025 and $1,897 by 2030. Thus, let's take a look at two industry-leading stocks poised to benefit from this trend.
1. Chewy
Chewy (CHWY, Financial) is the most popular “pure play” online pet retailer in the U.S. with over a 40% market share. The company supplies a variety of pet products from food and treats to medical supplies and even pet costumes.
Solid financials
Chewy reported solid financial results for the fourth quarter of 2022. Its revenue was $2.71 billion, which beat analyst forecasts by 2.21% and increased by 13.4% year over year. This is not too bad given the e-commerce industry is currently going through a cyclical downturn, which has impacted the sales of discretionary items sold by Chewy.
A positive for the company is it generates 73% of its revenue from auto-ship purchases. This is fantastic as it effectively means customers have their orders automatically placed, which should help to maintain solid sales even during a tough macroeconomic environment. This process could also act as a competitive advantage against physical retailers such as Walmart (WMT, Financial), as it can be time consuming to haul huge bags of pet food home every week or month.
Chewy also has major plans to expand internationally, which means an even larger total addressable market. I believe countries such as the U.K. would find the service valuable.
Profitability is often a major challenge for most e-commerce companies, including giants such as Amazon (AMZN, Financial), which is due to their low margins. In this case, Chewy’s management has made profitability a “north star metric,” which is a positive sign. The company has yet to achieve high profitability, but at least it's been reportinga positive bottom line in recent quarters. It booked a 270 basis point increase in its gross margin to 28.1% for the fourth quarter of 2022.
Its net loss of $64 million in the foruth quarter of 2021 turned into net income of $6 million in the fourth quarter of 2022. These fantastic results was driven by a supply chain transformation which included the automation of more facilities, while also closing older fulfillment centers. The company has a fourth automated fulfillment center coming online in 2023 and thus further cost efficiencies are expected to be achieved.
During tough times, a solid balance sheet is vital, especially when a company is teetering on the edge of profitability. In this case, Chewy reported $697 million in cash, cash equivalents and short term investments compared to debt of less than $500 million, which is mainly driven by operating lease liabilities.
Valuation
Chewy trades at a price-sales ratio of 1.51.
The GF Value chart indicates a fair value of ~$85 per share and thus the stock is significantly undervalued at the time of writing.
2. Zoetis
Zoetis (ZTS, Financial) is a global health care company that specializes in the treatment of animals of all types. This includes everything from household pets (dogs and cats) to livestock. The company is a leader in vaccines, medicines and even genetic testing for animals. Since the pandemic, people have become more conscious of the spread of viral diseases. In animals, there have been similar pandemics such as the “Foot and Mouth” disease which occured in 2001 in the U.K. and resulted in the slaughtering of over 6 million cows and sheep to prevent the disease from spreading. Zoetis produces a vaccine to help prevent the this disease as well as many others, including feline leukemia and canine parvovirus. To many people, a pet is like a member of the family, so pet owners will pay often huge amounts on medical care to keep their pet alive and well.
Mixed financial results
Zoetis reported mixed financial results for the fourth quarter of 2022. Its revenue was $2.04 billion, which beat analyst forecasts by $34.4 million and increased by 3.71% year over year. This may not seem like a very fast growth rate, but it was faster than the 0.6% growth rate reported in the third quarter.
Its overall revenue growth was highly diversified and positive results were reported across its top 13 markets. The U.S. increased sales by a strong 7% year over year and international sales rose by 9%, which was solid.
Its companion animal portfolio was the strongest performer with 14% sales growth year-over-year and it now makes up 64% of global revenue. Its small animal products were particularly strong with its “Simparica Trio” growing by a blistering 58% year over year to $744 million in sales. The Simparica franchise includes a range of chewable tablets for dogs which solves the issue of trying to force a dog to take a tablet. Its core “trio” product prevents worms, fleas and heartworm disease in a single tablet, which is a strong value proposition.
The overall result by Zoetis was offset by a weak livestock business, which reported a 2% decline in sales. This was driven by supply chain constraints and competition in the market.
Zoetis also reported solid profitability with operating income of $694 million, which increased by 16% year over year.
The business also has $3.58 billion in cash and short term investments on its balance sheet compared to debt of over $8 billion, but the vast majority of this ($6.6 billion) is long-term debt and thus manageable.
Valuation
Zoetis trades at a price-earnings ratio of 36, which isn’t exactly cheap, but it is 14% cheaper than the company's five-year average. The company also trades at a price-sales ratio of 9.97, which is ~11% cheaper than its five-year average.
The GF Value chart shows a fair value of $202 per share and thus the stock is modestly undervalued at the time of writing.
Final thoughts
Both Chewy and Zoetis are incredible businesses that are poised to benefit from the growth in the popularity of pets. Chewy is a play on the growth in general household pets and the future of e-commerce, as it continues to disrupt traditional brick-and-mortar retailers, whereas Zoetis is a health care provider for the entire animal industry and thus is poised to benefit from pandemic prevention in livestock as well as the growing number of household pets.
