The pet business is a great place to invest in, because the industry is both resilient and growing. People are unlikely to stop buying pet food or medicine for their furry friends, even in a weak economy. But looking forward, there is a clear trend that Petco Health and Wellness (WOOF 3.53%) CEO Ron Coughlin calls the "humanization" and "premiumization" of pet care. Put simply, pet owners increasingly view their pets as important members of their family. That means they're spending more on premium pet foods, healthcare, and toys to prolong and enrich their pets' lives.
The industry is also benefiting from the growing number of pets in this country -- the ASPCA estimates 23 million Americans adopted new pets during the pandemic. Put it all together, and it's clear pet care can be a huge opportunity with powerful growth drivers behind it, a solid combination for any portfolio. Here are my top two pet care stocks to buy now.
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1. Petco: The ultimate one-stop shop for pet owners
Petco Health and Wellness is leaning into the "wellness" part of its name, and the result is a stickier, more diversified company. While pet food keeps customers coming in on a regular basis, Petco also provides veterinary services, grooming, training, and even pet insurance, making it a one-stop shop for pet owners.
The company's Vital Care program gives customers access to unlimited veterinary visits, discounted grooming, discounts on food, and other perks for just $19.99 per month. This source of recurring revenue creates a flywheel effect and provides Petco with a moat against online sellers that compete in the category like Amazon and Chewy.
The company now has over 282,000 active Vital Care members, who spend more than normal customers, ultimately accounting for a lifetime value (LTV) that is 3.5 times higher than that of non-members. With the number of Vital Care members nearly tripling year over year in the second quarter, recurring revenue surged 54%. The program has plenty of room to keep growing, and Petco just opened up Vital Care to owners of small pets, reptiles, and birds. CEO Ron Coughlin says the company has a "robust road map of enhancements to come," which will allow it to "add many more members and capture further share of wallet."
Petco also gained 325,000 net new customers in the second quarter, good for its 14th straight quarter of customer growth, indicating that this all-encompassing strategy seems to be gaining traction.
The stock trades at 17.5 times forward earnings, right in line with the average multiple for the S&P 500. This is an attractive valuation for a company with strong tailwinds to sustain its current momentum. Its price-to-earnings growth ratio (PEG) of less than 0.7 is also a strong sign the pet company is undervalued relative to its earnings growth, making shares of Petco a compelling buy.
2. Franchise Group: The under-the-radar play
The inclusion of Franchise Group (FRG) here may seem like a bit of a curveball since the company is probably best known for its unsuccessful bid to acquire Kohl's earlier this year, and for its ownership of Vitamin Shoppe. But Franchise Group is also home to a thriving pet supply franchise -- Pet Supplies Plus -- which could prove to be a major growth engine embedded within the company.
As of June 2022, there were 644 Pet Supplies Plus locations, and management sees a long-term opportunity to more than double that number to approximately 1,650 stores. About two-thirds of existing locations are franchised, and there is high demand for new Pet Supplies Plus franchises -- the company reported there is already a backlog of 230 franchises right now.
Additionally, Pet Supplies Plus recently acquired Wag N' Wash, which offers self-service pet bathing, professional grooming, and an assortment of treats, food, and accessories. There are currently 15 Wag N' Wash locations in the United States, but Franchise Group will certainly be looking to expand its footprint.
Pet Supplies Plus has grown at impressive rates over the past three years. Revenue surged from $732.5 million in 2019 to $1.12 billion in 2021, up 53%. Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) expanded at a similar pace over the same period, rising from $59.9 million in 2019 to $93.2 million last year. So while Franchise Group isn't exclusively involved in the pet industry, Pet Supplies Plus is a key segment contributing about one-quarter of the overall company's top and bottom lines. It should account for even more going forward given management's long-term plans to expand the chain.
And the stock trades at a valuation of just 8.5 times forward earnings estimates. To further entice investors, Franchise Group boasts a dividend currently yielding 7.4%. That dividend is well-covered with a payout ratio of just 24%, meaning the company has considerable runway to increase the dividend over time.
With the "premiumization" of pet care and rising rates of pet ownership serving as tailwinds for the pet industry in the United States, Petco and Franchise Group are two profitable companies offering affordable exposure to the long-term growth of this market.
