Freshpet (NASDAQ: FRPT) is Building Economic Moat in Rapidly Growing Industry

Freshpet NASDAQ: FRPT was trading at all-time highs right before the onset of the pandemic. But after the natural pet food company’s shares lost around half their value in less than a month, they have come roaring back, nearly tripling off the lows and trading at nearly 40% above those pre-pandemic highs.

Freshpet recently reported its second-quarter earnings and surpassed consensus revenue and earnings estimates… But recorded a mere $200,000 in net income.

While earnings will take time to materialize, revenue growth has been extremely impressive. And Freshpet’s business model gives it a high likelihood of keeping the competition at bay for years to come.

Accelerating Revenue Growth

In Q2, Freshpet’s revenue increased 33.2% yoy to $80 million, beating analyst estimates of $77.1 million. Earnings, though quite low, beat expectations of a 7 cents per share loss.

Freshpet has had incredible growth over the past six years, with its average yoy revenue growth coming in at 25.3% over the past 24 quarters. And its growth rate is only accelerating – Freshpet’s revenue has grown at an average rate of 29.2% yoy over the past four quarters.

A lot of companies have been hesitant to provide full-year guidance in an unpredictable economic environment. Not Freshpet.

The company raised its full-year net sales guidance from $310 million to $320 million.

Chewy NYSE: CHWY is another example of a pet company that raised guidance after the pandemic started, showing that the pet industry has been immune from COVID.

A Recession-Proof Industry

Maybe it’s not surprising that the pet industry has prospered during the pandemic. After all, with many people stuck at home, it would stand to reason that they are spoiling their pets now more than ever.

But looking back, we can see that the pet industry has been resilient in the face of previous economic slowdowns. According to the American Pet Products Association, U.S. pet expenditures have not seen a single year-over-year decline in at least the past 25 years.

And it’s not like growth grinded to a near standstill during the last couple of recessions that didn’t force people to stay at home more – pet care spending grew 29% during the 2001 recession and 17% during the 2008-09 recession.

You may be thinking:

How much room is left for growth in this industry?

 Around 68% of U.S. households own a pet, a figure which has increased by around 2% annually since 2011. But pet spending has increased at almost 7% annually over the same period, showing that pet spending growth is far outpacing pet household growth.

Pet spending growth can outpace pet ownership growth far into the future. Furthermore, it’s not as if people that own pets won’t buy additional pets…

Here are some dollar figures for context:

In 1994, U.S. pet expenditures were less than $20 billion. In 2019, that number came in at $95.7 billion.

And around 41% of that money is going towards pet food.

Fridges Provide Economic Moat

Freshpet has a unique way of getting its foot in the door with mainstream retailers, providing branded fridges and coolers that exclusively stock its products.

With the fridge installed, a retailer is less likely to discontinue Freshpet’s products. And it’s not as if retailers are going to put several pet food fridges in their stores. One – or a few, max – is likely enough.

The numbers show that Freshpet is continuing to expand its footprint beyond its 22,000 stores. In its Q2 earnings call, Freshpet noted that it:

• Expects to get into 1,000 net new stores in 2020.
• Added 764 second fridges in Q2.
• Upgraded 186 fridges in Q2.

Valuation is Lofty

Freshpet is trading at around 14.1x forward sales and at over 400x forward earnings.

Those numbers make Freshpet look expensive, but the share price seems a lot more reasonable when you consider:

• It has a market cap of less than $5 billion in a nearly $100 billion a year, and growing, industry.
• Freshpet’s revenue is expected to grow by around 25% in each of the next two years. Revenue growth could easily continue at 20%+ well into the 2020s.
• The company has an excellent economic moat.

Freshpet shares are a risk; there’s no guarantee that earnings will grow to a respectable level in the future. But the risk/reward is great, as Freshpet can realistically grow enough to make its current price look very cheap.

Shares are Extended

Although I like Freshpet at its current share price, it is extended, spending the month of August flirting with overbought territory on the RSI.

The 50-day moving average is almost 15% below the current price. I’d look for a pullback to the 50-day – perhaps the share price and 50-day will meet around $100 – before getting in.

Keep an eye on Freshpet; it’s an excellent play once the chart gives you the go-ahead.