How to profit from pampered pets beyond the pandemic

As soon as lockdown began in early 2020, millions of people worldwide decided to invest in a furry friend to replace the humans they were banned from seeing. Giles Money of Sarasin & Partners notes that in 2020 the percentage of US households with a pet jumped from 52% to 56%. However, the surge in pet ownership induced by the pandemic merely reinforced a long-standing trend. 

Even with most restrictions now over, the market should continue to expand for years. Longer life expectancy, demographic and cultural changes, and our growing tendency to treat pets as little humans should all ensure that the global pet industry will continue to expand by around 8%-9% a year.

The surge in ownership

The growth in the pet population in the US and other major markets has been greatly accelerated by Covid-19, says Daniel Miller, portfolio manager of the Gabelli Pet Parents Fund. The isolation caused by lockdowns created a “need for companionship”. People were at home far more than usual, so those who had been putting off pet ownership because they were worried about leaving an animal alone all day were now able to care for one. The rise of online e-commerce also “made it easier to buy pet accessories and food”.

The pandemic-induced rise in pet ownership is an intensification of a trend that long predates Covid-19. “People are now much more aware of the enormous health and emotional benefits to having a pet.” Even the oft-mocked cat pictures and videos on Facebook, YouTube and Instagram are encouraging younger consumers to get a canine or feline companion.

Miller notes that pet ownership is now particularly popular with those in their 20s and 30s, especially since people in these age groups “are delaying marriage and having children”. Even those who are married or living together are finding that they can “get great pleasure from owning a pet”. One statistic that Miller thinks really underlines this cultural shift comes from the fact that in 2020, “85 million [American] households had a pet, compared with only 45 million who had a child under 25”.

The trend is particularly advanced in the US and UK, which both have higher per-capita levels of pet ownership than the rest of the world. However, the “rest of the world is starting to catch up”. Even in developing countries, where the idea of having animals as companions was once seen as alien, younger people are starting to embrace pet ownership. 

This is partly driven by cultural changes caused by exposure to images of pet ownership on television and social media, but another reason is that the emerging middle classes “now have more disposable income to spend on pets”. Mike Iddon, chief financial officer of retailer Pets at Home, agrees that there has been a big explosion in pet ownership in the past few years, with “demand greatly exceeding supply” in the UK during the pandemic. He estimates that three million pets have been acquired in Britain during this period. Cats and dogs comprise the lion’s share. But the numbers of fish sold has also risen sharply “after a steady period”, while children’s pets, such as guinea pigs and hamsters, have also been “incredibly popular”.

“Humanising” pets

People are not only more likely to own a pet these days, says Iddon, but they are also treating them differently. A growing tendency to humanise, or anthropomorphise, their pets means people are increasingly likely to consider them “part of the family”. This is good news for companies such as Pets at Home: “if you can win over a pet owner” and retain their loyalty through good service, “you can enjoy their business for the lifespan of the animal”.

Of course, this presents a challenge as well as an opportunity. Securing consumers’ loyalty is not necessarily easy given their “increasingly high” expectations, especially when it comes to “more advanced products”. The good news is that there has recently been “a lot of innovation” in this area. 

To take one example, dog bedding has advanced tremendously from the blankets and pet basket that used to be the norm only a few years ago. Now, you can find bedding that is “self-warming”. The sophistication of dog leads has also greatly improved in the last few years.

In the longer run, Iddon sees some human technology crossing over into the animal sphere, especially in the areas of fitness and nutrition. Pets at Home, for instance, sells a range of “dog-activity monitors”. These devices provide security and allow owners to ensure that their dogs are getting enough exercise – in the same way that humans use Fitbits.

Fine dining, not just fuel

People’s growing pursuit of healthy nutrition has also led to a change in the market for pet food. The large pet-food manufacturers who dominate the sector have hitherto generally focused on producing food for the budget-conscious owner. 

This food, known in the business as “kibble”, relies on keeping costs low by using the cheapest ingredients as well as additives to bulk it up. However, there is an increasing awareness among pet owners that “cats and dogs can survive on the cheapest food, but not thrive”, says Mark Scott, CEO of pet-food subscription service Bella & Duke.

Pet owners are being convinced through social media and word of mouth that “good-quality food is just as important for animals as for humans”, especially as they get older and more prone to disease, says Scott. Feeding animals cheap food “is like putting diesel in a Ferrari”. There’s also a strong economic case for spending a little more on food, since reducing vets’ bills by introducing a better diet can make the supposedly cheaper alternatives a “false economy”. As a result, the large pet-food conglomerates are increasingly under pressure as consumers shift towards premium brands and specially formulated food.

Indeed, the rise in pet ownership among millennials and “Generation Z” is already starting to transform the pet-food industry, says Lucy McKinna, creator of vegan pet food brand Noochy Poochy. Not only do these owners want to make sure that their pets have the healthiest diet possible, but they are also willing to “dig deeper into their pockets for food that will make a difference, in terms of the wider environment”. Five years ago McKinna, who owns a “food-obsessed rescue Doberman”, came up with the idea for a vegan pet-food brand on the basis that it would “align better with my ethics”.

Pet food goes green

However, while her dog loved it, and she says there is strong scientific evidence that “dogs can digest grains much better than previously thought”, she received the “cold shoulder” from manufacturers and distributors. Now, though, she has been able to get her brand up and running and is in advanced talks with two major wholesalers. 

Some of her first orders came from “employees of pet-food companies” who were eager to see what they had been missing out on. J Sainsbury estimates that at least a quarter of the population in the UK are partly vegetarian or vegan, so it is no surprise that pet-food firms are making an effort to appeal to this market. 

Mars Petcare, one of the largest pet-food manufacturers in the world, recently developed Lovebug, an insect-based dry cat-food product. Created from black-soldier-fly larvae, and sold in British UK supermarkets, it is aimed at pet owners who care about sustainability, since it takes up only one-fifth of the land that a comparable amount of beef uses. Mars has also developed several other products that focus on reducing the environmental impact of pets, including a system for composting cat litter.

Medical care on a par with humans

The consequences of humanisation extend beyond more lavish creature comforts. Medical care is another thriving subsector. For instance, Pets at Home is offering a subscription service that entitles members’ pets to regular check-ups for worms and fleas. However, it also includes more advanced treatments, “which, in some cases, are now on a par with parts of human medical care”, says Mike Iddon of Pets at Home.

Pets at Home has branched out into veterinary services, and currently operates 440 veterinary practices, the majority of which are in stores. Under this joint-venture model, vets “retain clinical and operational freedom” while Pets at Home helps to support them by taking care of property, IT and finance. 

This model, used to build practices from scratch rather than acquiring existing ones, allows both sides to take advantage of economies of scale in procurement and advertising, and share learning and knowledge across practices.

CVS Group goes one step further, providing a fully integrated veterinary-care system, according to its CEO Richard Fairman. It owns its own laboratories and specialist hospitals as well as vet clinics, so it can invest in diagnostic equipment, such as cardiac resynchronisation therapy and magnetic resonance tomography scanners for its frontline vets to help them deal with more complicated cases. 

The images produced by this advanced equipment are then sent to one of CVS’s specialists, who makes a diagnosis and formulates a treatment plan. Fairman thinks that there are other benefits to employing vets directly. CVS’s vets are “part of a clinical team that can support them in their day-to day activities”. 

This includes the development of clinical protocols based on best practice, as well as access to a programme of professional development. There is also a strong emphasis on well-being and mentorship at the company. Fairman believes this helps the vets avoid the high levels of depression prevalent in independent practices.

Lightning progress with drugs and treatments

Fairman believes that preventative care can play a key role in helping pet owners ensure that their pet has a long and healthy life, which is why CVS offers a Healthy Pet Club with regular consultations and advice from the vet. 

Still, no matter how good they are, vets are ultimately dependent on the tools and drugs that they have available. The good news is that the drugs and treatments now on offer are “much more advanced than... only a decade ago”. They can provide hope even for conditions “previously considered inoperable”, such as cancer. Pet owners and vets are also increasingly willing “to pursue last-ditch options”. The upshot is that pets are now far more likely to recover from serious illnesses. 

All this has created “strong and sustainable momentum” for companies that develop the drugs and diagnostic treatments used by vets around the world, says Jamie Brannan, president of international operations at Zoetis, the animal-health giant. 

Brannan notes that while Zoetis used to derive approximately two-thirds of its revenue from livestock and farm animals, the increased amount of money now spent on pets means that in 2020 around 54% of its sales came from its companion-animal segment. What’s more, pet owners should expect more options in the near future as Zoetis has been able to keep “major [research and development] programmes and regulatory reviews on track”, even during the pandemic.

Brannan also points out that Zoetis has enjoyed recent successes in a wide range of areas, from “arthritis pain and inflammation” to “skin allergies, parasitic disease and bacterial infection”. The treatment of osteoarthritis is particularly promising, especially since the increasing lifespan of dogs and cats makes these conditions much more common. 

Zoetis recently received regulatory approval for Librela and Solensia, two injectable monoclonal antibody therapies that help treat osteoarthritis pain in dogs and cats. In addition to its range of traditional drugs, Zoetis is also developing better diagnostic technologies. 

This includes Vetscan Imagyst, a diagnostic platform that uses “a combination of image-recognition technology, algorithms and cloud-based artificial intelligence to deliver rapid testing results to veterinary clinics”. Vetscan has already made its debut in several major markets, including Australia, Ireland, New Zealand, the UK and the US. 

The stocks to buy now

Daniel Miller of the Gabelli Pet Parents Fund is particularly bullish about the American company PetIQ (Nasdaq: PETIQ), which operates 3,400 vet clinics within large stores such as Walmart. This makes the process much more convenient, “since, rather than having to wait while your pet is checked, you can drop it off, go shopping and then collect it later”, says Miller. PetIQ also develops and manufacturers its own medicines, pet food and accessories. Despite explosive growth, which has seen its revenue triple since 2017, it still only trades at 18 times 2022 earnings. 

One way to play the boom in British pet ownership is through Pets at Home (LSE: PETS), Britain’s best-known pet retailer. In addition to selling pets and pet accessories (including food), it operates 440 vet practices in a joint venture with the vets. 

Over the past five years revenue has grown by 44%, or nearly 8% a year, with a solid return on capital expenditure (an important gauge of profitability) of just under 10%. This more than justifies the fact that it trades on a 2022 price/earnings (p/e) ratio of 23. 

CVS Group (LSE: CVSG) has also done well from the boom in pet ownership. The company owns a large number of vet practices, employing around 15% of vets who deal with small animals. It also owns laboratories, specialist pet hospitals and even crematoria. 

While CVS is focusing almost exclusively on the UK for now, it has a small presence in the Netherlands and is currently monitoring the situation in France and Germany to see whether recent regulatory changes will make corporate ownership of clinics viable. While the company trades at a relatively high 32 times earnings, its revenue is growing fast, almost doubling between 2016 and 2020.

PetMed Express (Nasdaq: PETS) is an online pharmacy selling a wide range of veterinary prescription medication in the US, from flea and tick medicine to drugs to combat complex conditions, such as heart disease and arthritis. Traditionally, most consumers have bought medicine directly from vets. But more and more have found that it is cheaper to get a prescription and then buy medicine online, a practice that received a huge boost during lockdowns, when many surgeries were closed. With solid recent sales growth of around 5% a year, PetsMed trades on a 2022 p/e of 19 and yields 4.3%.

The amount that the Japanese are spending on their pets, especially cats, is also increasing, which is good news for the Japan Animal Referral Medical Centre (Tokyo: 6039). The company operates several animal hospitals that deal with serious illnesses referred to it by a network of around 3,747 clinics (just under a third of the market), including kidney-disease and cancer cases. It also provides diagnostic and imaging services to vets’ practices. Sales have grown by around 6% a year for the last five years, while profits have been growing by double digits. Despite this, the company trades on a 2022 p/e of 16.

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