Brocker.Org: Citi Sees ‘Premiumization’ in Pet Food Category

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A recent Citi group report indicates that “humanization,” or the phenomenon of pet owners treating their animals as part of the family, has driven the U.S. pet food category to grow at a compound annual growth rate (CAGR) of 4.6% over the past decade.

As humans love their pets like never before, analysts say they’re more likely to shell out on expensive premium pet food, favoring smaller, niche brands that market all-natural and healthier alternatives. (See also: Top 3 Pet Food Stocks of 2016.)

Millennials Favors Niche Brands

The Citi analysts highlighted a new study suggesting that nearly half of America’s pets sleep in their owners’ bed every night. As Millennials, who already value sustainability and wellness more than older consumer cohorts, view their cats and dogs closer to the same level as their children, they tend to make food choices on behalf of their pets that look a lot similar to their own. As a result, the same trends disrupting the consumer space at large, such as an affinity for premium, environmentally friendly and health-conscious products, have permeated the pet food industry.

“As a result of humanization, pet parents tend to focus more on the well-being of their pet, and are willing to pay a premium for pet food of higher quality that delivers a health and wellness benefit,” wrote the Citi analysts.

Companies such as high-end brand Blue Buffalo Pet Products Inc. (BUFF), along with traditional pet food leaders Nestle SA (NSRGY), Colgate Palmolive Co. (CL) and J.M. Smucker Co. (SJM) have seen their market shares shift and their strategies change in response.

Analysts pointed to the Global Pet Expo in Orlando, Fla., last month, which featured only premium and natural pet food lines instead of mass-market brands. “Clearly that speaks to where the large companies themselves see where the pet food market is going in terms of growth,” wrote Citi. In the $28 billion pet food market, which is expected to reach $35 billion in 10 years, 68% is traditional mass-market pet food while 32% is premium grade pet food. Over the next decade, Citi foresees the premium segment gaining a 38% market share, amounting to $13.4 billion.

What Drives Premiumization

Analysts say Millennials are increasingly willing to pay extra for premium food—$234 per year for dogs, $100 per year for cats—adding that 68% of households with pets are skewed toward higher incomes.

“In our view, this low absolute difference to ensure your pet has better food is a reasonably low barrier to induce consumers to trade up and bring about the further premiumization of the overall category.”

Citi analysts reiterated a buy rating and raised their price target to $33 on shares of Wilton, Conn.-based pet food company Blue Buffalo, adding the stock to its U.S. Focus List. Following a recent sell-off​, Citi says investors are presented with a “terrific opportunity to own the best U.S. Food growth story at an attractive valuation.” In particular, analysts see upside in the launch of Blue Buffalo’s new dog food brand, Earth Essentials.

Long-Time Favorites Innovate and Acquire

As Purina owner Nestle has lost out to Blue Buffalo-type rivals, the world’s largest food company has gone the acquisition route, buying natural and organic pet food maker Merrick in 2015 for $300 million. “Nestle may have thus decided to act as an incubator, using its balance sheet to buy new entrants and disruptors, and then leveraging its distribution capabilities and scale to roll out the niche brand,” suggest the analysts. (See also: Consumer Packaged Goods Sank 2.5% in Q1.)

Smucker on the other hand, is finding a middle ground by aiming for a “mass premium opportunity” with its new Nature’s Recipe brand, which recently launched in mass and grocery channels as well as pet superstores. Citi indicates that the move offers “grocery consumers an-entry-level premium brand” that “compares more favorably to the competitive set.” Citi is upbeat on Smucker’s ability to “capitalize on the potential for grocery consumers to trade up by broadening access to a premium product in a channel that consumers visit more frequently to do every day shopping.”

Moving forward, niche brand or not, it’s clear that consumers are shifting to more eco-friendly and health-conscious options, from cleaning products to cars and gourmet meals for their pets. As a result, the old industry players will need to rebalance a new norm or continue to see their market share swept away by Millennial-targeting new brands. (See also: The Consumer Staples Industry Is in Trouble.)

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