How investors can profit from pet owners

Nearly 60% of Canadian households own pets, and Canadian Pet Market Outlook 2014 adds there are about 5.9 million dogs and 7.9 million cats being cared for. Further, Canadians spend $6.5 billion on their pets.

These figures show that pet ownership is at an all-time high, and those levels are expected to increase as people continue to recognize the health benefits. In fact, studies show that owning pets can help retirees feel they have a sense of purpose. And pets are also being credited for decreasing recovery time for those who are ill, as the companionship improves people’s moods.

Read: How to gain veterinarian clients

There’s also the societal notion amongst many that a pet completes a family.

Here’s how investors can profit from this trend, as well as the resulting increase in pet-related expenditures.

Zoetis (ZTS)

We’ve owned this company’s stock since its IPO in February 2013. Spun off from Pfizer, Zoetis develops and sells pharmaceuticals for pets and livestock. The company stands to benefit from both the increase in pet ownership, as well as the need for more livestock pharmaceuticals due to the increase in meat-based diets (think Asia).

Read: Vacation options for your dog

Zoetis is the largest global animal health company in the world, with more than 50% market share, and it’s the only firm in the field that employs its own sales force to call on vets, farmers and animal hospitals. We also love that in spinning off Zoetis to unlock its value, Pfizer has held on to 80% of the shares itself, which signals that they also see a great future for this standalone company.

We first started purchasing Zoetis in February 2013 at 32.37. It’s currently trading at $44.01, for a return of 36% so far.

VCA Inc. (WOOF)

Veterinary practices and animal hospitals are fragmented businesses. Few operators own more than a handful of locations, so it’s an industry ripe for consolidation.

Read: 5 instances owning a dog saves you money

With that as our investment thesis, we set out looking for a company with just such a modus operandi—a company looking to consolidate. We discovered VCA Inc. This U.S.-based company is strategically purchasing animal hospitals and clinics continent-wide to launch a network of hospitals and diagnostic labs, creating economies of scale. We especially like this company, given there’s no government regulated fee-billing guide from which vets must operate. This allows their pricing to be market driven.

We first purchased VCA Inc. on July 2014 at $37.46 per share. It currently trades at $53.39, for a return of about 42.5% so far.

PetSmart (PETM)

A company we suggest avoiding is PetSmart, operator of the largest pet store chain in North America. It has done a good job of creating a one-stop shop for all things pet. But a core of their business is pet food, which lower-cost competitors like Amazon are selling at lower and lower prices. The only way PetSmart can survive is to lower prices in kind, and we suggest you stay away from any business stuck in such a downward pricing spiral.

Read: Lessons from a veterinarian

We also don’t like the amount of debt taken on to get the recent deal done. In fact, the company’s shares have already had a run up in the last year, after BC Partners (a private equity firm) bought it in December 2014 for $8.7 billion—the largest leveraged buyout in the U.S. last year. And BC Partners borrowed a whopping $6.95 billion to complete the transaction, so they’ll be concentrating on paying down debt for years to come.

So while it’s true that PetSmart generates a lot of free cash flow, the math tells us that going forward much of that cash flow will be needed for servicing debt. Not good. We do not own any shares of PetSmart. It currently trades at $82.49.

The opinions expressed are those of the author and may not necessarily reflect those of Manulife Securities Incorporated. Manulife Securities Incorporated is a member of the Canadian Investor Protection Fund.

Steve Barban and Russell Hope have been providing Gentry Capital Un-Common Sense© to their clients for many years. They are financial advisors with Gentry Capital/Manulife Securities Incorporated.