Pet food companies drive value despite challenges, says investment bank

The last two years have been a rocky ride for the pet food industry; the pandemic-induced bubble has burst, and operators have been left fanning overheated supply chains whilst grappling with inflation and reduced consumer spending power.

“The second half of 2020 through to mid-2022 - these were great times for the industry, and because there was so much press around supply chain challenges and shortages, consumers wanted inventory, and the trade wanted inventory,” Tim Larsen, global co-head of Houlihan Lokey's Consumer Group, told FeedNavigator.

“The last couple of years have been quite different and the overstocking has had to be reversed - the consumer wants less in the pantry, and so does the trade. Then that sends out a signal and people get nervous that the market is drying up,” he said.

Slower rate of growth​

This reversal of supply chain overheating has conspired with other economic factors, such as inflation and reduced consumer purchasing power, to slow the pace of growth in the pet food market, said Larsen.

Despite this “noise,” he said that on a secular basis the pet food industry is still on an upwards trend.

“Pet population growth is still outpacing human population growth and people are still spending more on their pets than they have historically…There may be noise around the trend line, but I haven’t heard anybody really question it or say that they no longer think that it is a 30-year trend.”

He said this is cause for optimism in the pet food space and that looking ahead, the market is poised for growth, with an abundance of opportunities.

“The secular trends still hold true. It is just a case of getting some of the noise related to economic conditions to quieten down and fade into distant memory,” he said.

Trends: Premiumization, naturalness, health, alternative formats​

Asked to elaborate on the key trends governing the market, Larsen cited pet humanization as an underlying driver, fueling growing demand for premium and natural products as well as health-led pet nutrition.

“Pet nutrition - spanning supplements, nutraceuticals and technologies that enable owners to manage their pets’ health - is an emerging opportunity,” he said.

Not even the current climate of reduced spending power is deterring consumers from buying these products, in particular millennial pet owners. According to Houlihan Lokey, this group’s preference for high quality, health focused products and its willingness to pay premiums for such items is driving innovation and growth in premium pet foods and wellness products.

Demand for alternative pet food formats, such as freeze-dried, refrigerated/frozen, and fresh foods also continues to rise, the investment bank reported. It said these formats are outperforming traditional kibble, reflecting consumer demand for less processed, nutrient dense foods.

However, although these alternative formats offer more opportunities than traditional formats, Larsen warned that there are “questions around the profitability dynamics” in some of those segments.

He said that the cat food category offers more growth potential than dog food as, despite being smaller, the cat space is less crowded.

M&A: Caution causing trepidation​

Despite a slowdown in M&A activity following the pandemic-era boom, private equity and strategic acquirers continue to seek opportunities in these high-growth segments, according to Houlihan Lokey.

“I think that generally there is hunger because people believe in the long-term trajectory, whether that is the private equity investor base or strategic acquirers in the space; they remain committed to it,” said Larsen.

At the same, he has observed some trepidation around buying or selling at the wrong time.

“People are being overly cautious - even if they believe in a business long term. That’s on the buyer side, and on the seller side it isn’t dissimilar. People have businesses they want to monetize, but if they’re not showing their best foot in terms of their business results, they will be a bit uneasy,” he said.

“In short, there is belief in the long-term M&A potential of pet food, particularly in the areas that are less saturated.”

Notable deals​

Asked to highlight some of the most significant deals that had taken place in the pet food space over the last 18 months, Larsen was not short on examples.

He named Mars Petcare’s acquisition of Champion Petfood’s and J.M. Smucker Co’s divestiture of several pet food brands to Post Holdings, and the merger of Natural Balance and Canidae as the largest transactions.

General Atlantic’s £280 million ($353m) investment in fresh dog food company, Butternut Box, was interesting in that it showed people are still willing to pay for top-tier assets, he said.

Meanwhile, Gryphon Investors’ investment in Vetnique Labs, a maker of specialty pet products including supplements and topical solutions for digestive health, allergy and dermatological support and ear care, demonstrated that the high-value health segment is still attractive to investors, Larsen said.

“What I take from all of this activity is that people are still committed to value creation plans in the pet space, and that’s not going to change,” he said.