Chewy, Freshpet and Zoetis pressured by supply chain woes

The number of pet owners boomed during the pandemic. Now, pet care companies like Chewy, Freshpet and Zoetis are experiencing challenges related to a stronger US dollar and supply chain constraints.

• Morgan Stanley projects the pet care industry to grow by 8% annually between now and 2030
• Pet care “remains an attractive and defensive investment”, according to analyst Simeon Gutman
• Chewy, Freshpet and Zoetis are top 10 holdings in the two main thematic ETFs

As consumers look to cut back on their discretionary spending in this high inflation environment, the question for Chewy [CHWY], Freshpet [FRPT] and Zoetis [ZTS] is whether pet care is a luxury item that consumers will still be able to afford.

Research published by Morgan Stanley earlier in November predicts the pet care industry will grow at a compound annual growth rate of 8% over the rest of the decade. The average household spend on pet care will rise to $1,320 per pet by 2025 and $1,897 by 2030. This is compared to its previous forecast of $1,292 by 2025 and $1,909 by 2030.

“An outcome in line with this expectation would increase total spending in the industry by 134% over the next decade, from $118bn in 2019 to $277bn by 2030,” wrote Morgan Stanley’s Simeon Gutman, an equity analyst covering hardline, broadline and food retail.

The Chewy share price is down 26.73% year-to-date through 14 November, but up 30.98% in the past month. The Freshpet share price is down 29.55% year-to-date and up 18.6% in the respective periods. The Zoetis share price is down 39.99% and up 0.72% in the respective periods.

Net income under pressure

While the long-term forecast for the pet care industry looks healthy overall, the near-term outlook for Chewy, Freshpet and Zoetis is a mixed bag.

Chewy, which supplies pet products, rebounded to a net profit of $22.3m in the three months to the end of July from a net loss of $16.7m in Q2 2021. Ahead of the Q3 2022 earnings report later this month, third-party data published by YipitData has indicated that the company should exceed the Q3 sales estimate of $2.46bn, reported Yahoo Finance last week. This would be a growth rate of roughly 11% year-on-year.

Freshpet, which sells refrigerated food for dogs and cats, saw net sales rise 40.7% to $151.3m in Q3 2022. However, its losses widened to $18.4m versus a $2.1m net loss in the year-ago quarter. Freshpet's CEO Billy Cyr said in a statement that the company is taking “remedial actions” to address cost-cutting challenges and get to grips with margins.

Zoetis, which sells pet health products, disappointed in Q3 2022 with revenue up just 0.6% and 5% operationally from the year-ago quarter. Net income was down 5% to $566m.

Runway for growth

In a statement issued with the Q3 2022 results, Zoetis CEO Kristin Peck said the company was lowering full-year guidance due to “continued supply chain constraints, veterinary workforce challenges and recent changes to foreign exchange rates”.

Things should turn around at Freshpet, which announced a new CFO at the start of the month, who will help to drive margin expansion. Oppenheimer analyst Rupesh Parikh wrote in a note to clients seen by StreetInsider that Freshpet could be an acquisition target as it has “a significant global runway for growth”. William Blair analyst Jon Andersen does not foresee a takeover of the company, and described the actions the company is taking to improve margins and operations as “value added”.

Parikh views Chewy favourably as well.Long-term investors should look beyond near-term trading volatility and focus on the fact the company has a strong balance sheet and booked a profit in the first half of its fiscal year.

“On the whole, the pet category remains an attractive and defensive investment across both food and products, as well as vets, insurance and other services, making investment in the pet sector relatively low-risk,” wrote Morgan Stanley’s Gutman.

ETF performances

Chewy is currently the top holding in the Rize Pet Care ETF [PETZ.L], with a weighting of 10.61%. Freshpet and Zoetis are the third and seventh, with weightings of 7.09% and 4.9% respectively. The fund, which launched in April, is down 21.98% so far, though has gained 11.3% in the past month.

Zoetis is the third top holding in the ProShares Pet Care ETF [PAWZ], with a weighting of 8.9%. Chewy and Freshpet are fourth and sixth and have been allocated 8.2% and 4.71% of the portfolio respectively.