US-Cashing in on Creature Comforts

It's not just pooches that are being ever more lavishly pampered, says Amy Tsao on BusinessWeek Online. Cats, birds and even ferrets are "being treated like family members" these days. Pet ownership has risen by 19% to 64 million households in the past decade, making animal food, supplies and services a $31bn industry. And the boom is not over. Aided by favourable demographics (ageing baby boomers are buying pets for company, while the core pet market, households with children aged five to fifteen, is also expanding) the sector should produce average growth of 6% a year for the next few years. That makes pet superstores Petsmart (PETM) and Petco Animal Supplies (PETC), "nearly recession-proof investments".

The retailers are benefiting from a shift in the market that began in the early 1990s. At that stage, supermarkets were the principal suppliers of pet gear and food. But discount retailing giant Wal-Mart "gradually lopped off a major share of the market" as the average pet owner increasingly concentrated on price. At the same time, more affluent pet owners were enticed by the huge variety of products on offer at speciality stores such as Petco and Petsmart. These trends - which show no sign of abating - have reduced the supermarkets' share of the market from 65% to 35% over the past decade. Wal-Mart is the "clear" pet market leader, but Petco, and Petsmart especially, have thrived by differentiating themselves.

Petco's strategy has been to concentrate on "high-end" non-food products that "cost significantly more" than mass-merchandise brands. These now comprise about 65% of sales. Operating margins eclipsed 8% for the first time last year, and the company expects to increase them by 0.5% a year over the next few years. Petsmart, meanwhile, attracts customers with an "everyday low-price strategy" akin to Wal-Mart's, and is boosting its appeal with an emphasis on high-margin services, which still only comprise 6% of sales. It has expanded the capacity of its 50 in-store grooming salons and is testing the in-store Petshotel boarding concept in more markets.

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Even with Wal-Mart expanding, the pet market should produce growth over the next few years to keep Petsmart and Petco, which both plan to double outlets to around 1,200 stores, "financially healthy - and their shareholders purring happily". They are expected to boost earnings per share by 26% and 27% respectively this year, and should be able to grow this figure by 18-20% over the next three to five years, according to Joseph Feldman of Bear, Stearns and Co. He expects Petsmart and Petco shares to gain 30% and 27% by the end of 2004.