Inflation Gnaws at Pet Food Companies

Pet food bags are getting smaller and prices are up as companies try to maintain profits in the face of soaring commodity prices
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Pet owners, get ready for sticker shock. Retailers and manufacturers are hiking pet food prices, and the cost of kibble is expected to climb even higher in coming months. At PetSmart (PETM), the nation's largest pet-store chain, the cost of Hill's Science Diet dog chow is up about $2 a bag, to $36 this year, says Michael Sapp, vice-president of dog and cat consumables. Sapp notes that other top-selling brands such as Pedigree, manufactured by Mars, and Purina, made by Nestlé, have been shrinking the size of their bags. "We're getting price increases and package downsizing," he says. "People are paying the same amount for less product."

In recent years, as more Americans treat their furry friends just like another member of the family, the pet products industry has become a $41 billion-a-year business featuring such items as organic foods, diamond-encrusted collars, and private kennels with TVs tuned to the Animal Planet cable network.With the economy slowing and human food prices rising, some consumers are cutting back on such extras as a fancy new dog collar. But they're more likely to cancel a pricey vacation than change Fluffy's diet.

"I'm more interested in the quality than price," says Cathy Tuite, the Staten Island (N.Y.) owner of a miniature pinscher named Gracie. Tuite recently switched to grain-free, high-protein, oven-baked Wellness brand chow to address an issue with Gracie's pancreas. "They're not around long enough as it is," she says. "We have to take care of them."

The Incredible Shrinking Bag

Pet food manufacturers have figured out several creative ways to push through price increases. PetSmart's Sapp says the popular big green bag of Purina Dog Chow has shrunk from 50 lb. to 44 lb., but the retail price has remained the same at about $17. The story is much the same with Pedigree's Complete Nutrition, which has shrunk from a 44-lb. bag to 40 lb. That bag sells for about $18.

Blame the onward march of commodity prices for most of the price hikes on Fido's food. The price of key ingredients such as corn and rice, for example, are up some 30% in the past year. Pet food manufacturers say they have been able to offset much, but not all, of the commodity cost increases through the price hikes. "Like the entire food sector, we're seeing sharply escalating energy, transportation, and ingredient costs," says Purina spokesman Keith Schopp.

In his company's first-quarter conference call on Apr. 30, Ian Cook, chief executive of Colgate-Palmolive (CL), maker of Hill's products, said the 30% increase in commodity costs took the company by surprise. "When we forecast Hill's, we came into the year with good pricing already in place in the fourth quarter of last year, between 6% and 8%," he said. "We now have in place a double-digit price increase on that business, which will take effect at the very end of the second quarter."

No Signs of Trading Down

Cook said Colgate's pet food sales volume was still climbing but that the company's rising costs would leave pet profits flat to down for the year. In announcing his company's fiscal third-quarter earnings in late February, Del Monte Foods chief Richard Wolford said the company had put in place two pet-food price increases this fiscal year. Earnings in the company's pet products segment fell nearly 10%, to $77 million for the quarter. Del Monte makes pet food brands such as Meow Mix, Milk-Bone, and Kibbles 'n Bits.

Pet industry insiders say consumers aren't trading down to cheaper brands or shifting from more expensive wet food to dry because of the economy. Pet owners are traditionally brand loyal, even in tough times, because pets seem to know the difference. "You can't just change on them—I'm going down-brand today, here's your new food," says Joan Storms, a consumer products analyst at Wedbush Morgan Securities. "You have to feed them a little bit at a time so their digestive systems get used to it."

Retailers and analysts say sales of organic and natural pet food products remain strong, a category that got a big boost after last year's recalls of tainted pet food. These brands, many of them manufactured by small privately held companies, such as Blue Buffalo and Nutro Products, command high prices per pound. Their sales are being driven in part by the increased popularity of smaller lap dogs carried around by celebrities such as Paris Hilton.

Stocking Up at Big-Box Stores

PetSmart, for example, does a good business in Royal Canin food specifically formulated for Yorkshire terriers, which costs $13 for a 3-lb. bag. Ellen Degeneres recently began promoting the Halo line of "human grade" pet food, which costs $38 for a 17-lb. bag. "People are becoming much more conscious of what's in the bag," says Dave Bolen, chief merchandising officer of Petco stores.

That doesn't mean the economy isn't taking a bite out of pet profits in other areas, however. Faced with high gasoline prices, many consumers are consolidating their shopping trips, stocking up at supermarkets or discounter retailers such as Wal-Mart Stores (WMT) or Target (TGT) rather than making a separate trip to the pet store.

In announcing his company's fourth-quarter earnings on Mar. 5, PetSmart chief Phil Francis reduced his expected earnings for this year to approximately $1.59 per share, down from the $1.95 per share the company reported for 2007. He also said he was reducing the number of new stores he is opening by 20% next year and planning fewer new Pet Hotel boarding facilities at existing locations. "Our current situation is unlike anything this business has experienced in the past," Francis said. "The last time the consumer cut back to this degree was in the early 2000s."

While not cutting back on pet food purchases, consumers have been opting for fewer discretionary items such as dog beds and leashes. "Our sense of this is consumables are good, services are good, our new-pet sales are fine," Francis said. Where PetSmart is feeling an impact is products that owners might have replaced or upgraded in the past. "Meaning, it's a better collar or a coat," he said. "It's an annual event to buy one of those because it is out of fashion or, to use a phrase, dog-eared."

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