My Canary In The Coal Mine: Pets

This is the first note I’ve shared in some time as I’ve been dealing with personal issues over the last few months. Hopefully, as that comes to a close soon I’ll be able to publish more of my thoughts and opinions as I regularly had. I appreciate everyone’s patience in the meantime.

For my notes today, I wanted to talk about my updated thoughts on pets. Those who have followed me for a while now should know I’ve covered the pet industry as a thematic play for some time. However, 2023 has been quite a different kind of year than the one we experienced since COVID and a post re-opening.

I’ve recapped my thematic long points below as to why the industry was a good one.

All these points symbolized a pull forward in demand, however, with pets being considered a member of the family, spend was expected to continue to materialize in all other areas of the industry. Perhaps not at the same rate of growth but not to decline.

If you think about pet ownership, the bare minimum is being able to take it to the vet for shots/vaccines and food. In its most simplistic form, this means dry kibble, flea and tick, and shots/vaccines.

In the world of flush wallets, and treating their pets better than other family members, the net dollar benefits spill over into the below categories.

My point is that there was a dramatic increase in spending post-COVID than pre-COVID as people flush with cash wanted to spend on their new furry companion.

Naturally, the biggest “hedge” in this industry is that it’s sticky. Sticky meaning that once you get a pet, you’re responsible for it until it dies which depending on the animal can be a few years to a few decades.

This consistent spending ensured to a degree that growth would still be there as long as adoptions continued post the pull forward. With this in mind though, things took a shocking turn this year.

The pet trade, for the most part, has completely circled the drain. What’s tough to understand is that the reversal in the space meant fractures in the new-found relationship between owners and their pets.

Given that consumers are still under pressure with inflation from all corners of daily life, many have rethought how feasible it is to keep or replace a pet.

Take a look at adoptions/surrenders, which is rather alarming. According to Shelter Animals Count, a nonprofit working with more than 7,000 rescue organizations nationwide, shelters are in their third year of having too many animals and not enough adoptions.

Shelter Animals Count projects that by the end of 2023, the population gap will tick up to 5%. While owner surrender rates have fallen in recent years, there’s been an 8% increase in stray intakes from January to June 2023 compared to the same period in 2022, and a 26% increase compared to the same period in 2021.

This trend in pet ownership can be seen via Chewy’s (CHWY) Active Customer base, which topped out in Q4’21 and has lost nearly 300,000 customers since.

Similarly, Petco (WOOF) was seeing active customer growth but conveniently stopped reporting those figures for the last two quarters which can only mean one thing. They’re seeing the same thing.

The mystery of why the pet industry, which historically has been recession-proof, has seen a decline in spend and adoptions is a head-scratcher. Part of why we might be seeing this is because consumers are finally getting hit with the reality that dogs are a big responsibility. It was easy for many Americans to adopt a pet during COVID and spend so much time with them while also being flush with cash.

However, with all the spending just to maintain a pup and with return-to-office policies, things got expensive quickly, especially with animals that are having a hard time adjusting to post-pandemic life after years cooped up with their owners.

It may just be too much for some pet owners to handle; training can require a lot of time and effort that some people aren’t willing to spend. I’m sure many of you know of someone who isn’t doing what they should be doing and is getting frustrated that their pet is acting out.

A long time coming, but even shocked me based on the speed of the change is how consumers have transitioned from the narrative of getting the best for their pet to now just trying to find value.

Pulling a statement from Petco’s recent Q3’23 transcript

The company notes that there is quite the bifurcation of those who still seek premium and super-premium (think along the lines of Freshpet FRPT), and those looking for a deal. The problem is that a large portion of owners are now looking for that deal.

The other alarming issue is when it comes to small businesses. When you think of your local pet store, it’s mainly the local supply shop, daycare, or groomer.

However, when you think about the consumer hitting difficult financial times, shopping for value is the name of the game and the smaller players aren’t immune.

In a large Facebook chat of over 45,000 members across the U.S., I asked a simple question.

Based on the poll, things aren’t looking too good. Over half answered that their business was seeing a decline in sales versus last year.

I can almost guarantee you too that many of their customers have also stretched the cadence of their visits since we’re seeing that in our portfolio company at the moment.

I keep getting email blasts from my local daycare to the degree that I never received them.

Desperation is in the air and I don’t think the bottom is quite in yet.

The pain trade in Pet looks like it will continue and it’s very disheartening how many people took on this responsibility because they were either bored during COVID or thought their new work setup allowed them to do something they otherwise wouldn’t be able to and now have completely changed.

I feel bad for all the animals that have to go through this and hopefully, the pet space will rebalance after Americans can get a grasp on what their finances, work/life balance, and future look like.

Regardless, the ones that will come out on top I believe are the ones that can resonate with the customer and create a solid value ecosystem.

Until next time,

Paul Cerro | Cedar Grove Capital

Personal Twitter: @paulcerro

Fund Twitter: @cedargrovecm