Pet Food Quarterly Results Round Up: Q1 2016 (Part One)

The first of a 2-part review of the financial performance of pet food manufacturers in Q1 2016 focuses on Nestlé, Colgate-Palmolive and Blue Buffalo. Problems with its Beneful brand acted as a drag on Nestlé’s otherwise strong performance, while Blue Buffalo is now the leading premium brand in North America.

Nestlé narrows the gap on Mars…

Nestlé’s Petcare unit saw organic value sales rise by 5% year-on-year (y-o-y), to CHF2,925 million (US$2,947 million) during the first three months of 2016. Growth in pet food sales was particularly strong in Western Europe, Eastern Europe and Latin America. Nestlé’s share of global dog and cat food value sales rose by 70 basis points, to 24% between 2014 and 2015, narrowing the gap on Mars. Over the same period, the global share of leader Mars declined by 60 basis points, to 26%, largely due to the underperformance of its Whiskas cat food brand.

…but its Beneful brand struggles.

Nestlé’s Purina One and Pro Plan brands performed well in North America, as did the Merrick brand it acquired last year, but Beneful is losing ground. A class-action lawsuit was filed in the US early last year alleging that Beneful was making dogs ill. This seemed to impact sales, with the share of premium dog and cat food sales accounted for by Beneful in North America sliding by 80 basis points, to 7%, between 2014 and 2015. Speaking on a conference call in April 2016, Steffen Kindler, head of investor relations at Nestlé Investor, noted that Beneful’s sales began to struggle around March 2015 and that the decline had knocked 20 basis points off the profit margin of the pet care unit.

While Kindler claimed that Beneful sales were now beginning to recover, the brand was dealt another blow in March 2016 after the company issued a voluntary recall. According to Nestlé, internal tests found that Beneful wet dog food contained lower levels of vitamins and minerals than specified on the label.

Higher pricing continues to boost Hill’s margins…

Organic sales at Colgate-Palmolive’s Hill’s Pet Nutrition unit rose by 5% y-o-y during Q1 2016. Unit volume roses by 3.5%, with 1.5% higher pricing. Growth in volume sales was particularly strong in the US and Western Europe. The unit’s operating profit rose by 5% y-o-y during the quarter, to US$155 million, with its profit margin rising by 80 basis points to 28% of net sales. A recall of Hill’s Science Plan Tender Chunks in Gravy in the UK during May 2016 due to excessive iron levels is unlikely to have done any lasting damage to the brand.

…but it is weak in Asia Pacific…

Hill’s has stabilised its share of the North American premium dog and cat food market over recent years (accounting for 14% of value sales in 2015) in the face of a growing challenge from such brands as Blue Buffalo, but it is losing share to local player Unicharm in Japan (Hill’s share of value sales in this market declined by 220 basis points between 2011 and 2015 to 21%). Meanwhile, it remains significantly underweight in the rapidly expanding Chinese market (where it accounted for just 1% of value sales of premium dog and cat food in 2015).

…and may have a regulatory problem in the US.

In April 2016, the federal Food and Drug Administration (FDA) issued a final version of its Compliance Policy Guidance (CPG) on therapeutic veterinary diets. It confirms the FDA’s view that while therapeutic veterinary diets are technically “drugs,” it is “less likely” to initiate enforcement action when such products are marketed solely through licensed veterinary channels and direct “drug claims” are not made on the product label.

This represents a potential threat to sales of Hill’s’ brands through such channels as pet shops, pet superstores and internet retailing. However, it remains to be seen how stringent the FDA will be in terms of enforcement; the ambiguity of the language employed in the CPG suggests a considerable degree of wiggle room.

Blue Buffalo on track for more than US$1.1 billion in net sales this year…

Net sales at Blue Buffalo rose by 13% y-o-y, to US$280 million, during the first three months of 2016, with volume growth the main driver. Net sales of dry foods rose by 12%, to US$229 million, while net sales of wet foods, treats and other products grew by 13%, to US$51 million. The company is now forecasting sales of between US$1,125 million and US$1,140 million for 2016 as a whole, with a gross margin of between 43% and 44%.

Blue Buffalo’s gross profit rose by 24% y-o-y, to US$123 million, while its gross margin rose from 40% during Q1 2015 to 44% in Q1 2016. This increase in profitability was derived from supply chain efficiencies, particularly the ramp-up of its Heartland manufacturing facility in Joplin, Missouri, reduced input costs and higher pricing. Work on a second manufacturing facility has commenced in Greenfield, Indiana.

Blue Buffalo remains assiduous in targeting the grain-free trend. During Q1, it launched 16 new SKUs of dog food and treats in its Wilderness product line, including two new original recipes, Bayou Blend and Denali Dinner. Bayou Blend contains alligator, catfish and shrimp, while Denali Dinner contains wild salmon, venison and halibut. It also launched grain-free Wilderness Wild Rolls. It continues to muscle in on Colgate-Palmolive’s home turf with its Natural Veterinary Diet product line. According to the company, its veterinary channel sales grew by “mid-to-high single digits” y-o-y during the quarter.

…as it diversifies its distribution…

Blue Buffalo is particularly strong in internet retailing, and the ongoing expansion of this channel bodes well for its growth prospects. According to the company, its e-commerce sales are expanding at a “double-digit” rate, with sales of products specifically targeting puppies and kittens particularly strong. In a conference call on 10 May, Billy Bishop, President and COO, noted that this indicated that growth in internet retailing was “not cannibalising any of our current business” and that Blue Buffalo was “margin agnostic” between the online and offline channels.

CEO Kurt Schmidt added that Blue Buffalo was enjoying “double-digit growth in our brick-and-mortar stores [excluding pet superstores], including regional and neighbourhood pet stores [‘middle single digits’] and farm and feed stores [‘mid-to-high single digits’].” Nonetheless, pet superstores still accounts for just over two-thirds (68%) of the company’s value sales, where it has been putting product specialists (which it calls “pet detectives”) in-store to drive sales.

…and seeks to become a global player.

The company’s share of premium dog and cat food sales in North America continues to expand, reaching 11% in 2015. As recently as 2011, this figure was just 5%. It has now overtaken Mars’ Iams brand to become the leader in this segment and may even overtake Pedigree to become the leading brand across dog and cat food as a whole during 2016. The brand has been launched in Mexico and Japan, with further launches planned in China, Brazil and Belgium (a bridgehead into Western Europe) as Blue Buffalo seeks to make the leap from being a regional to a global player.