James joined Platinum as an investment analyst in the consumer team in 2019. Prior to this, James was at Columbia Threadneedle Investments in London from 2012 where he started as.. More
The shift in work and home dynamics since the onset of the pandemic has been a boon for consumer spending on home furnishings. The pet and pool industries are experiencing a similar Covid windfall, but interestingly, their stocks have not performed as well as one would expect. A recent trip to the US provided the Platinum consumer team with some first-hand insights on why that’s the case and the opportunities this may present.
Arriving from Sydney, New York City always feels busy, but with office occupancy at just 40% and subway ridership at 60%, the city’s recovery is slow everywhere, except in the rental market, which has seen rates soaring to record highs. Hybrid work practices are now commonplace, and some companies are shifting to southern states attracted by lower costs, taxes, and warmer weather. US census data highlights the migration trend and the recent shift towards smaller-population centres (see Fig. 1).
Fig. 1: Population shifts according to US Census data
Source: United States Census Bureau.
For the love of pets
The change in dynamics has created a boom in the pet industry, but it may surprise many to learn that two growing companies in this sector are trading at stock prices below their pre-Covid levels. Freshpet is the US market leader in all-natural ingredient, refrigerated pet food. The company is well positioned for trends towards natural foods and rising spending on pets, driven by millennial and Generation Z pet adopters and the overall trend towards the “humanisation” of pets. The category faces unique challenges, including manufacturing processes and packaging in order to maximise shelf-life without preservatives. The company installs fridges at retailers from Walmart to Wholefoods to stock and display their product. Retailers are optimistic about growth in fresh pet food and are increasing the number of stores carrying Freshpet products and the number of fridges per store. However, Freshpet has struggled to keep up with demand in the last two years (filling as low as 50-60% of retailer orders). The company has also seen material cost inflation in ingredients, production machinery, and labour, which has hurt margins – and its share price. Since 2019, the company has increased prices by 17% and plans to increase prices by another 4-5% this year. These price increases, together with new and more-efficient capacity coming online, are expected to help rebuild profitability, which has actually declined from pre-Covid levels.
Chewy, America’s second-largest online pet supply retailer (Amazon is number one), benefited from increased pet adoption and customers shifting their purchasing from stores to online during the pandemic. This channel shift has been reversing in the last year as some consumers returned to their previous behaviour patterns, leading to a slowing in sales for online retailers. Pandemic-related manufacturing and logistics disruptions are persisting, and the cost of products, warehousing and packing, and shipping continue to rise. Chewy has gradually increased retail prices to catch-up, but margins have taken a hit. During a meeting with the company, management explained that for habitual purchases such as pet food (most of which is made on auto-ship programs), price increases must be measured and gradual to avoid shocking the customer and prompting them to consider alternatives. While profitability on shipping competitively priced and heavy dog/cat food items is low, the company aims to be the online pure-play leader in the category and raise profitability by cross-selling to customers into higher-margin areas, such as private label, pet general merchandise, pharmacy products, insurance, and services. While this appears to be a sensible online retail strategy, investor appetite for presently unprofitable companies like Chewy is low.
A deep dive into pools
The pool sector is benefiting from migration to sunbelt states where pools are more common. The total number of pools in the US has slowly increased over time, while equipment spending per pool is rising structurally as consumers adopt more features such as saltwater chlorinators, heaters, and variable speed pumps. Extraordinarily, in the last 18 months, cost inflation in materials, labour, and freight has resulted in 20% price increases at the manufacturer level. Chlorine prices have doubled since pre-Covid levels, exacerbated by a US factory burning down, reducing supply, with a high-cost imported product filling the gap.
Despite these price increases, consumer demand has been strong due to people spending more time at home (in houses that have risen in value). According to PK Data, new inground pool construction grew by 50% from 78,000 to 117,000 between 2019 and 2021, and total industry sales are up 65% over that period (see Fig. 2).
Fig. 2: US residential pool market (total industry sales)
Source: PK Data.
In this favourable environment, it is unsurprising to sceptical investors that the private owners of pool companies took the opportunity to conduct an initial public offering (IPO) on favourable terms. Leslie’s (retailer) came to the market in October 2020 at US$17 and Hayward (equipment manufacturer) listed in March 2021, coincidentally also at US$17. These companies derive most of their revenue and profits from the US residential pool market by selling equipment and chemicals. Both companies experienced strong share price gains post their listings, reaching highs of around US$30 (Leslie’s) and US$27 (Hayward) in mid-to-late 2021, but have since fallen sharply to current levels of around US$15 and US$13, respectively.
During our meeting with the management team at Leslie’s, we discussed the cyclical vs. secular factors that are impacting demand. The company believes rising home prices, outdoor lifestyles, and sunbelt migration are supportive, and pointed to a 58-year history of growth, with a modest -1% same-store sales decline during the global financial crisis. Leslie’s competes on service, range, and convenience, and believes consumers buy sporadically from potentially lower-priced competitors, such as Home Depot or Walmart, but return to Leslie’s when they need water tests or specialist advice. Management explained that sales of above-ground (temporary pools), spas, accessories, and toys are expected to fall from elevated levels, making the outlook difficult.
The US market for pool equipment is dominated by US Pentair, Hayward, and Spanish company Fluidra (which bought US-based Zodiac in 2018). The US pool industry has consolidated over many years. Consolidation often results in oligopolistic behaviour, and favourable margins and returns for participants. Management at New Jersey-based pool equipment manufacturer Hayward explained that the cost of manufacturing has risen 25% from pre-Covid levels, and that 70% of costs are raw materials with labour costs only ~10%. Hayward has increased prices by 26% and is aiming to maintain its gross profit margin in percentage terms, not just its absolute dollar margin. Achieving this would be an excellent result, and we will watch with some anticipation, as it presents an excellent test of competitive behaviour in the industry. Management believes consumer price sensitivity is low given that equipment costs are a small component (US$7,000 average) within the total inground pool build cost (average US$55,000), while replacement demand is mostly non-discretionary upon failure. We are attracted to the long-term fundamentals of the industry, and will be keenly observing results ahead.
Overall, our trip to the US and various company meetings has provided colour to our understanding of some of the powerful demand and supply impacts that Covid and US stimulus have had on a number of industry segments in recent years, and on the price increases currently being experienced. With investors increasingly concerned about trend reversals and a potential recession, we are seeking out areas where concerns that are being overplayed could manifest into opportunities.
 Source: PK Data.
 Source: Leslie’s.
 Source: FactSet Research Systems, as at 27 July 2022.
 Source: Hayward.
DISCLAIMER: This information has been prepared by Platinum Investment Management Limited ABN 25 063 565 006, AFSL 221935, trading as Platinum Asset Management (“Platinum”). While the information in this article has been prepared in good faith and with reasonable care, no representation or warranty, express or implied, is made as to the accuracy, adequacy or reliability of any statements, estimates, opinions or other information contained in the articles, and to the extent permitted by law, no liability is accepted by any company of the Platinum Group or their directors, officers or employees for any loss or damage as a result of any reliance on this information. Commentary reflects Platinum’s views and beliefs at the time of preparation, which are subject to change without notice. Commentary may also contain forward looking statements. These forward-looking statements have been made based upon Platinum’s expectations and beliefs. No assurance is given that future developments will be in accordance with Platinum’s expectations. Actual outcomes could differ materially from those expected by Platinum. The information presented in this article is general information only and not intended to be financial product advice. It has not been prepared taking into account any particular investor’s or class of investors’ investment objectives, financial situation or needs, and should not be used as the basis for making investment, financial or other decisions. You should obtain professional advice prior to making any investment decision. You should also read the relevant product disclosure statement and target market determination before making any decision to acquire units in the fund, copies of which are available at www.platinum.com.au/Investing-with-Us/New-Investors.
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