PetSmart Still Has a China Problem

Although leading pet-supplies retailer PetSmart (NASDAQ: PETM  ) agreed to pull from its shelves pet food products sourced from China after rival Petco similarly announced it would do so, this has been a known, widespread problem in the industry for many years and raises the question, "What took so long?"

Pet food, generally, has a quality control problem. Leading manufacturers Nestle (NASDAQOTH: NSRGY  ) and Procter & Gamble initiated scads of recalls over contamination and fears of Chinese-sourced ingredients that have spawned class action lawsuits, including one filed in 2012 involving Nestle's Purina division that also ensnared PetSmart (Nestle is defending the claim on PetSmart's behalf). The FDA has been issuing cautionary warnings on pet food products as far back as 2007 and last week said it's received thousands of complaints, some 1,800 in the past six months alone. Over the past seven years it knows of over 1,000 dogs that have died.

Yet other than pull products from the shelves when a problem comes to light, the industry has done little to correct the situation, taking a reactive posture, rather than a proactive one. PetSmart, with nearly $7 billion in annual revenues, is the leading industry outlet for pet supplies yet only said it would remove Chinese products after Petco did and then won't have them completely off its shelves until March of next year.

Its rationale for taking its time with clearing the racks is that some of its customers like the Chinese products and it wants to find suitable replacements first before eliminating them. It would seem the risk to the health and well-being of what it commonly refers to as the "pet babies" of its customers, not to mention the risk of further lawsuits, would outweigh the inconvenience.

Admittedly, it's not easy to find alternatives. According to an article in the Cleveland Plain Dealer from 2012, the Pet Food Institute says there's not enough chicken produced in the U.S. to meet demand for chicken breast treats. Since the Chinese prefer darker cuts of meat, white meat breasts for dog treats end up being sourced from there. Moreover, the vitamins and minerals the foods are supplemented with are virtually unavailable from anywhere but China (and that goes for the human vitamins as well). Some 90% of all vitamin C is imported from China, as well as most vitamin A, B12, and E.

And China has serious quality issues of its own all across its food chain. Chemicals used in brake fluid and antifreeze were found in toothpaste. Chinese mothers go to great lengths and are willing to spend exorbitant sums to buy infant formula and dairy products from global brands because they don't trust local producers. From fake milk powder to dairies adding melamine to infant formula to boost protein levels (melamine is an industrial compound used as a binding agent and flame retardant), hundreds of infants and children were killed and thousands more were sickened. Scandals still erupt within the industry there today.

The FDA hasn't exactly been much help, either, in protecting animal health. In January of last year, Nestle, Del Monte, and Hartz Mountain yanked Chinese chicken jerky treats after it was discovered that illegal antibiotics had been added to their products, but the FDA said it didn't believe they were the cause of the illnesses recorded.

Pet food is a near-$23 billion a year industry in the U.S., the largest component of overall pet care expenditures, which totaled $55.7 billion. If pet parents start losing their trust in the food they feed to their pets -- and an argument can be made they have -- then not only will the makers of the food like Nestle and Colgate-Palmolive have a problem, but retailers will as well.

PetSmart just completed a major reset in its consumables department, planning to capture the growth the segment represents, particularly in the super-premium category.  But unless it becomes more proactive than reactive to the problems the industry faces, this pet-supplies retailer may find investors continuing to climb a great wall of worry over China, and the loss of a quarter of its value as it's recorded so far this year will be just the beginning of a bigger decline.

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