Pet obesity is becoming a widespread problem in countries such as the UK, the US and Canada. In fact, it is now estimated that more than half of the pets in the US are overweight, and around half of these are clinically obese. Since the condition often leads to more serious diseases such as arthritis, diabetes or other problems that can run up a vet bill, Colgate-Palmolive (NYSE:CL) is betting that pet owners would be more than willing to throw in the extra buck if it means a healthier diet for their beloved dogs and cats. 
Colgate-Palmolive supplies pet nutrition products through its Hill’s Pet Nutrition subsidiary whose portfolio primarily consists of medically-attested, healthy solutions that help pets deal with clinical conditions such as obesity, allergies, intestinal problems, etc. The brand contributes around 13% to both the company’s overall revenues and operating profit. Since 2008, however, the segment’s growth has stagnated. One may assume that the reason lies in the market rather than the company. But this overlooks the fact that the market for pet food in developed countries is actually growing faster than home care and personal care solutions – the segments in which Colgate-Palmolive has fared quite well over the last few years as far as top-line growth is concerned.
Historically, the pet foods segment offered Colgate-Palmolive the highest margins with the the brand’s focus on health-based innovation allowing it to keep its pricing strong. In the third quarter of 2012, for example, the company increased the prices for Hill’s products by around 4%. This also resulted in a net volume decline of 2.5%, but the premium pricing emphasizes the company’s view that Hill’s is a special, scientifically formulated product which is tuned to the health of pets rather than the generic pet food labels available.
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This strategy certainly feels like a gamble on the part of Colgate-Palmolive. One would think that pet food spending would be one of the first areas consumers cut back during times of economic uncertainty. High-end brands like Hill’s would be the first to suffer in such a scenario. On the other hand, if macroeconomic conditions remain largely stable, one would expect that the rising prevalence of obesity and other health related issues would drive more pet owners towards specially formulated pet foods such as Hill’s.
Colgate-Palmolive certainly seems to be betting on this. The company plans to launch Science Diet Dry, a label for pet foods made from natural ingredients towards the end of 2012. The company has also lined up the launch of a new low-fat, fat-burning pet food called ‘Prescription Diet Metabolic’ for 2013. Meanwhile, the company is also focusing on improving its packaging and labeling in order to emphasize the latest innovations in its products, which it considers a key area for improvement.
We are optimistic on the company’s prospects in the pet food market. Assuming again that macroeconomic conditions help more than hamper the company’s overall performance, we see Hill’s increasing its market share gradually over the next 6-7 years. Apart from the factors mentioned earlier, the company’s extensive marketing expertise and a history of working closely with veterinary organizations should also stand it in good stead in the eyes of pet owners.
We currently have a Trefis price estimate of $105 for Colgate-Palmolive, which is slightly below the market price.Notes: