EY-Parthenon Perspectives

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1 EY-Parthenon Perspectives Investing in the pet industry Andres Saenz, Managing Director, Co-head of Private Equity February 7

2 Executive summary Opportunities in the pet industry for PE investors Large and growing market, supported by the humanization-of-pets trend, driving increased consumer spend on both products and pet-related services $ Growth in the premium and natural segment, presenting opportunity for new market entrants and brand building High levels of M&A activity from strategic buyers looking to expand their portfolio and creating attractive exit opportunities for investors Significant growth in the retail channel, alongside a large potential opportunity in the online space EY-Parthenon Page

3 Overview of opportunities in the pet industry Positive dynamics Watch-outs Growth in the market is being driven by a steady increase in the number of pets in the US Trend toward the humanization of pets drives consumers to invest more in their pets Despite this overarching trend, not all sub-sectors within pet food and supplies are benefiting equally, and the trend is beginning to mature Pet food, including treats, has demonstrated strong growth at the premium end of the market, and opportunity exists for growth of mass-premium brands Strategic buyers continue to look for ways to expand their premium offerings in their portfolios, presenting exit opportunities for investors The demand for premium pet food products has driven a proliferation of brands and has created a higher need for brands to define a differentiated positioning play a critical role for manufacturers by gaining broader distribution for brands, especially smaller brands, and managing relationships with thousands of retailers Much of the consolidation of distributors has happened, and a few key distributors have already emerged (e.g., Phillips, Central Garden & Pet) Pet superstores and regional chains have experienced significant growth, and regional chains are expected to continue to grow E-commerce is small but will be a source of growth going forward Independents have seen growth decline and have just recently stabilized While e-commerce has generated growth, pure-plays are not yet profitable and the impact of Amazon is significant New products and services are emerging such as better tracking and monitoring of pets Opportunity exists in the vet roll-up segment of the market Changes in Rx regulation may create opportunities Top-line growth in vet services has been relatively slow While offerings such as pet insurance have limited penetration, evidence has not surfaced to support longterm attractiveness EY-Parthenon Page

4 The number of pets in the US has grown steadily US total number of pets (dogs and cats), US pet household penetration m 8% 6m 6m 7m 6m 79m 68% m m 6 6% Total number of pets Percentage of households with pets Source: IBISWorld; American Pet Products Association; EY-Parthenon Consumer Survey (n=,) EY-Parthenon Page

5 The pet parent trend has driven spend, particularly in the higher-revenue premium and natural product segment US premium dog food market, US premium cat food market, Commentary $b 8 $8b $8b $9b $9b $b $b Premium wet Premium dry Premium share of 9% 9% % % % % market CAGR ( ) 6.% 8.%.9% $b Premium share of market $b $b $b $b $b Premium dry Premium wet $b % 6% 7% 7% 8% 9% CAGR ( ).8% 7.9%.% The humanization of pets has resulted in pet parents who treat their animals as one of the family There is a clear, long-term trend towards pet anthropomorphism/ humanization in the US, driven by such factors as urbanization, longer life expectancy, shrinking household sizes and greater social atomization... People are treating their dog food like some people are treating their baby food. Euromonitor... resulting in revenue growth among players The natural pet product market reached $.b in, growing rapidly at a CAGR of 7% since 8. Forrester Many natural and organic foods and treats have gained popularity, experiencing % growth rates in previous years and providing lucrative sources of revenue. IBISWorld Dog food is growing at a % CAGR, with cat food at a % CAGR Source: EY-Parthenon consumer survey (n=,) EY-Parthenon Page

6 Small brands and high-growth specialty manufacturers have experienced the greatest growth in recent years US pet food market by company share, 7 Commentary $b $9b $b $b $b $b $6b $7b $9b CAGR (7-) % % % 8% % 8% Increased growth and competition has spurred M&A activity in the pet food space, particularly in the premium segment In June, Blue Buffalo also filed for an IPO, and [was] expected to raise US$ million with its first stock offering. The growing popularity of premium dog and cat food, which is projected to grow significantly faster than the broader categories, will likely create new merger activity. Companies like Freshpet, Blue Buffalo, WellPet and Diamond Pet Foods will remain attractive targets for both investors (in the form of IPOs or private equity firms) and other manufacturers. Euromonitor Other smaller niche players are gaining share, largely as a result of the pet parent trend 7 8 Nestle Mars Del Monte P&G 9 Colgate Palmolive Blue Buffalo Private label Others 6% P&G sells Pet Care division to Mars and Del Monte s Big Heart Pet Brands sold to JM Smucker for ~$6b () This strong growth at the premium end of the market is being driven in large part by a boom in sales of socalled alternative dog and cat food. These include offerings that fall into such categories as organic, holistic raw and human-grade.... Many of these products are manufactured by small enterprises. Among these small companies are numerous start-ups and mom-and-pop operations. Euromonitor Source: Euromonitor; The New York Times, Reuters, FoodProcessing EY-Parthenon Page 6

7 Natural/premium products are gaining shelf space in all channels; regional chains carry a much more extensive line Percentage of pet food shelf space occupied by natural/premium brands % 7 shelves Non-natural/premium 7 shelves 8 shelves 8 6 K9 Natural Stella & Chewy's Pinnacle Nutro Canidae Weruva Tiki Dog Halo Diamond First Mate Nutrisource Professional Lotus Holistic for Health Premium Edge Taste of Wild Non-natural/premium Canyon Creek Avo Derm Nature's Recipe Solid Gold Merrick Nature's Variety Wellness Natural Balance Non-natural/premium Royal Canin Vet Diet Innova Meow Mix Authority Nature's Recipe Simply Nourish Wellness Nutro Nature's Variety Blue Buffalo Natural Balance Nutro Blue Buffalo Wellness Hill's Hill's Pet Food Express Petco PetSmart Number of brands Regionals provide much 6 greater access to natural/ premium brands, even 7 with less shelf space Source: EY-Parthenon store visits; EY-Parthenon independent and regional pet retailer survey (n=8); Retailer visits and calls; News articles; Capital IQ; One Source; Hoovers; AC Nielsen; EY-Parthenon consumer survey; company websites; Mintel; EY-Parthenon analysis EY-Parthenon Page 7

8 play a critical role in the value chain, especially for independents Q: Do you (manufacturers) consider the small independent pet retailers an important channel for your products? Q: Approximately what percentage of your (independents) pet food supplies is sourced through a distributor? Commentary % 8 6 n=6 No % 8 6 8% or more Independents and regionals play an important role for manufacturers; these channels tend to rely more heavily on distributors as opposed to the pet superstores You go to distributors because of slow-turning products, or expertise in the channel. The regionals don t leverage their buying power right now. If it s franchised, they will do it even less. Former VP of Merchandising, regional pet chain Companies continue using distributors even after reaching the scale to go direct because it is much better utilization of their assets. It allows them to focus on building their consumer base. VP of ing, pet distributor association Yes Importance of independent channel 6% to 79% % to 9% % to 9% Less than % Today 8-9% of my products are through distribution. I prefer going through distributors. Part of it is the relationship I have with them and part of it is that I can buy - individual items instead of a pack of if I want to add it to my store. I don t expect any major changes to this going forward. Owner, independent pet store Most of my supplies come from a distributor. I like sourcing through distributors because of being able to access more products at the same time. Owner, independent pet store What we sell through distributors are going to both regionals and mom and pops. Regional chains and independents don t have the mass and volume to hit the minimum order point to go direct. President, pet product manufacturer Source: EY-Parthenon independent and regional pet retailer survey (n=8); EY-Parthenon interviews EY-Parthenon Page 8

9 A variety of retail channels sell pet food and supplies Overview of pet food and supplies retail landscape Brick-and-mortar-focused Online-focused Pet superstores Pet specialty Regional chain pet retailers Independent pet retailers Hyper-markets/ mass merchants Other Grocery stores Club/other stores Pet-focused online retailers General online retailers Description Large national pet specialty chains > total units Units typically >k sq. ft. Regional pet specialty chains - total units Units typically 8K- k sq. ft. Local pet specialty chains/ single stores < total units Units typically <8k sq. ft. Large-format stores carrying a variety of products, typically at discount prices s focusing on grocery/food products, including national chains and independents usually selling a variety of products which customers are required to buy in wholesale quantities Online-only pet specialty retailers selling a wide range of pet food and supply products Online-only general retailers selling a wide range of product categories CAGR % % for all pet stores exclusive of superstores % for all pet stores exclusive of superstores % for hypermarkets; <% for mass merchants <% % 8% for all of online 8% for all of online Examples PetSmart PetCo Pet Supplies Plus Pet Supermarket Petsense Petland Pet Food Express Catnip-Bones Paws & Claws Cause to Paws Walmart Kmart Target Safeway Shaws Kroger Costco Sam s Club BJ s Wag PetFlow Pet6 PetCareRX Amazon ebay Source EY-Parthenon independent and regional pet retailer survey (n=8); Company websites; EY-Parthenon analysis EY-Parthenon Page 9

10 Within the pet specialty channel, pet superstores are growing faster than regional and independent pet shops US pet specialty store revenues by channel, Source: NAICS, SEC filings; Euromonitor; company websites Note: Regional chain is defined as an enterprise with more than retail locations nationally as of EY-Parthenon Page

11 Spend on veterinary services has grown at a CAGR of % historically and is expected to grow at % through Expected veterinary services revenue and revenue per clinic, 7. CAGR ( ) Projected growth in veterinary services revenue ( CAGR) per IBISWorld 6.% Revenue per clinic %.8. % Year-overyear change Number of clinics.%.6%.%.%.%.%.%.%.% 7k 8k 8k 8k 9k 9k 9k k k Source: IBISWorld; BLS; BEA; U.S. Census; EY-Parthenon analysis EY-Parthenon Page

12 Increasing pet expenditures and trends toward pet humanization have supported this steady growth US pet industry total expenditures, E US annual visits per pet and spend, 7 8 CAGR CAGR ( ) ( ) ('-') Annual visits Annual spend $ 6 Live animal purchases Live animal purchases Other services % % -% 9%.6.6 Other services Supplies/ OTC med Supplies/ OTC med %.7.6 Total spend Veternary care Veternary care % Dog Cat Food Food % 7 Total pet expenditure has grown steadily over the past years, with large increases in veterinary care and other services Source: American Pet Products Association; American Veterinary Medical Association Pet owners are spending more at the vet or on OTC medications, a trend that offsets flat vet visits EY-Parthenon Page

13 About EY-Parthenon Parthenon joined Ernst & Young LLP on August 9,. EY-Parthenon is a strategy consultancy, committed to bringing unconventional yet pragmatic thinking together with our clients smarts to deliver actionable strategies for real impact in today s complex business landscape. Innovation has become a necessary ingredient for sustained success. Critical to unlocking opportunities is EY-Parthenon s ideal balance of strengths specialized experience with broad executional capabilities to help you optimize your portfolio of businesses, uncover industry insights to make investment decisions, find effective paths for strategic growth opportunities and make acquisitions more rewarding. Our proven methodologies along with a progressive spirit can deliver intelligent services for our clients, amplify the impact of our strategies and make us the global advisor of choice for business leaders. About EY-Parthenon s Private Equity practice Private equity firms are constantly looking to make better-informed investment decisions, improve portfolio company performance and increase realized value. Over the last years, our private equity strategy professionals have worked with clients to address these challenges utilizing our deep sector knowledge and efficient and flexible processes to complete more than, strategic due diligence projects around the globe. We have a winning combination for the entire range of private equity strategy and transaction needs. Contact us Andres Saenz Managing Director, Co-head of Private Equity EY-Parthenon, Ernst & Young LLP andres.saenz@parthenon.ey.com Executive Assistant: Dominique Clervil dominique.clervil@parthenon.ey.com Follow us for regular updates Facebook facebook.com/eyparthenon/ LinkedIn linkedin.com/company/ey-parthenon EY-Parthenon Page

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