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Why Pet Stocks Are an Investor Treat

By Bradley Freeman - May 19, 2020 at 8:10PM

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How coronavirus trends elevate pet companies.

People have increasingly relied on the love of our furry friends to get through pandemic-induced shutdowns. I know that personally, I cling to the unconditional affection my dog gives now more than ever while the isolation persists.

For most industries, the pandemic directly halted business. Some restaurants and retailers are shuttering doors permanently, small business continue to struggle, and many industries remain in mandated zero revenue environments. Through all of this, we still love our pets, still spend liberally on their wellbeing, and still are integrating them into American culture at a growing clip.

Man and Dog

Getty Images

Encouraging Trends

Younger generations are more inclined to pay for pet healthcare, organic pet food, and more likely to own a pet than baby boomers. Spending power continues to grow among millennials and Gen Z, serving as a strong tailwind for the industry. The pandemic hasn't changed this and may have accelerated the trend. As such, any resilient growth sector through an epic catastrophe such as this is worth exploring.

Over the past several weeks, news stories have broken around the nation about animal shelters being empty for the first time ever. Beyond serving as a feel-good story, this is an investable phenomenon. All shelter animals once receiving bare-bones care based on limited funding are now going to new homes. Generally speaking, this means higher quality food, more consistent medical care, toys, and grooming for years to come. For companies providing these specific products and services, it means growing revenue. Seemingly, coronavirus is actually bolstering pet-related companies that are able to adapt.

I think this trend can continue. In response to the virus, large companies like Twitter announced a plan to allow employees to work remotely permanently. Cisco CEO, Chuck Robbins, in his earnings commentary expressed confidence in maintaining past levels of productivity with a totally remote workforce. They can now onboard employees from anywhere in the world. More and more employees can and will stay home indefinitely.

Changing World

Being home all day makes owning a pet easier, and being isolated all day makes that prospect incrementally more compelling. All of this, to me, is a perfect recipe for continued pet industry growth no matter the economic condition.

What's the best way to play this? Candidly, one of the main strengths of pet stocks is scarcity. There simply aren't a lot of pure plays to choose from in the segment but there are two that could be considered.

Chewy is an e-commerce pet supplier. They benefit from the double-whammy of a strong pet industry and the tailwind of e-commerce. My main issue with the company is the valuation. CEO Sumit Singh's company is not expected to be profitable until 2023, and trades over 300 times their operating cash flows with cash burn continuing.

Comparing Valuations

Their sales multiple is more modest at four times, but with a low margin business I find it unlikely to see further sales multiple expansion. Chewy operates in a rather commoditized food business which yields lower potential to turn sales dollars into profit, thus the modest sales multiple. Revenue growth this year will be a strength but still does not justify a $16 billion market cap. I believe that Chewy has bitten off more than it can masticate and the price is ahead of itself. That is why I prefer Zoetis (ZTS -1.05%).

Zoetis, a company more based in pet biotech, is more reasonably priced. The earnings and operating cash flow multiples sit at 35 times and 34 times respectively. They do actually have a higher sales multiple than Chewy at roughly 6 times, but significantly higher profit margins make that more palatable.

Cutting edge intellectual property in CEO Kristin Peck's healthcare products enables the company to enjoy pricing power and higher profit margins. Unlike many, they do not predominately make treats and toys, but rather lifesaving medications that are non-discretionary. Demand elasticity here is more muted than it is for Chewy, as alternatives to Zoetis's products are few and far between.

It is a gloomy, rainy day. I am not allowed to leave my home unless absolutely necessary, I am not allowed to socialize, and I do not know when that will change. For me, and so many others, pets are the lovable solution to this period of isolation and loneliness. Seeds for long term change have been planted by the coronavirus, yielding fruitful future returns for pet companies able to keep up. From an investor perspective, Zoetis enjoys the perfect duo of solid intellectual property and limited competition. That is a combination I can get behind.

Bradley Freeman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Twitter. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Zoetis Inc. Stock Quote
Zoetis Inc.
ZTS
$170.64 (-1.05%) $-1.82
Chewy, Inc. Stock Quote
Chewy, Inc.
CHWY
$46.75 (-3.11%) $-1.50

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