Believe it or not, one of the best stocks on the market over the last five years has been Freshpet (FRPT 1.31%), the maker of fresh pet food for dogs and cats.
The stock has returned more than 2,000% over the last five years, benefiting from a number of trends, including pet owners spending more money on pets, a desire to feed pets healthier products, and pet humanization, or treating pets like members of the family. The pandemic has also been kind to pet product companies like Freshpet as pet adoptions spiked early in the pandemic. The pet product industry is recession-proof, and spending on at-home activities like pets has generally gone up during the crisis.
Image source: Freshpet.
As the chart below shows, Freshpet has actually underperformed peers like Chewy and Trupanion, even as the stock has more than doubled over the last year.
After an amazing bull run over the last five years, investors may be wondering if it's too late to get in on Freshpet stock. Let's take a look at some of the reasons to buy, and why you might want to take a pass.
A slow-motion disruptor
Some of the best stocks on the market, like Netflix and Amazon, have succeeded by disrupting a giant market slowly, in the process putting up steady growth and strengthening their competitive advantages.
Freshpet offers investors a similar value proposition. The company is disrupting the North American pet food market -- an addressable market of at least $31.7 billion -- by offering fresh, refrigerated food, differentiating itself from most pet food companies that sell dry or canned food. Its products are priced for mass consumption and it has installed Freshpet Fridges in more than 21,500 stores, helping to distinguish itself from competitors. It sees room for fridges in 30,000 stores in North America, and is also focused on international expansion, starting in the U.K.
The company's results speak for themselves. Over the last three years, Freshpet has posted revenue growth of better than 20% in each quarter, and gross profit and EBITDA has steadily improved as well, giving it more money to reinvest in the business.
For 2020, the company finished with $318.8 million in revenue, up 29.6% from the previous year, accelerating for the fourth year in a row, and reported adjusted EBITDA of $46 million, up from $29.2 million in 2019.
Based on those numbers, it's clear the company is executing on its Feed the Growth strategy, and since it's only captured 1% of its addressable market, there is still a huge growth opportunity in front of it.
One reason to be cautious
While Freshpet's steady revenue and EBITDA growth is impressive and the company is disrupting the massive pet food market, most of the stock's recent growth has come from multiple expansion rather than the fundamentals of the business. On a generally accepted accounting principles basis (GAAP), the company is only borderline profitable as it's invested in its capacity expansion through Kitchens 2.0 and its Feed the Growth strategy, which called for an earlier increase in advertising and other investments in order to drive growth, a strategy that has clearly paid off.
As the chart below shows, its valuation has expanded significantly on a price-to-sales and an EV/EBITDA basis.
FRPT EV to EBITDA data by YCharts
Still, Freshpet is far from alone in seeing multiple expansion like this. In fact, this pattern has become common with growth stocks , especially in the recovery from the pandemic. Low interest rates have driven a rotation into stocks, and investors seem to have priced in some future growth in companies that have benefited from the pandemic, like the pet products industry. So a higher valuation alone shouldn't be a reason to avoid the stock.
Is it a buy?
Considering its elevated valuation, investors shouldn't expect Freshpet to repeat the performance it's delivered in the last few years. Still, there are a lot of reasons to like this stock, including its reliable growth, huge market opportunity, recession-proof positioning, and pandemic-related tailwinds. Freshpet's track record alone show that it would be a mistake to bet against its success.
The pet products sector is one of the most promising in the broader consumer goods industry today given the secular tailwinds. Even after a remarkable run, Freshpet looks like a buy today. Expect the stock to continue to outperform the S&P 500.
Look out for 2021 guidance in its fourth quarter earnings report in February as that should help guide the stock over the next year.
