A Pet Food IPO Still Worth Owning

This company, which recently completed its initial public offering, could be the next great opportunity in the premium food market. But not the premium food market you’d expect.
The Renaissance IPO ETF (NYSEArca: IPO) is up 5.2% year-to-date, while the S&P 500 is up just 1.9%.
IPOs are hot right now and for good reason. (Pre-IPOs are even hotter—see here.)
Venture capital investments during the second quarter hit the highest level in 15 years. Venture capitalists funneled some $17.5 billion into pre-IPO companies during that quarter, which is quickly approaching the $22 billion we saw invested during the last quarter of 2000.
That means the IPO market could get even hotter, with the VCs looking to cash out via the public markets.
However, it’s becoming increasingly risky to invest in companies that have recently gone public. A recurring question is whether a stock’s meteoric rise on day one will hold up, or if it will come crashing down like so many have.
With that in mind, let’s look at one recent IPO that might just be special enough to warrant a post-IPO investment.
Blue Buffalo Pet Products (NASDAQ: BUFF), which began trading on the secondary market on July 22, has been one of the more successful IPOs over the last couple weeks, with shares up 40% from its IPO pricing.
But, more importantly, this pet food IPO is still reasonably priced, with the market not having bid the stock up to nosebleed levels. Consider the June IPOs of Fitbit (NYSE: FIT) and Wingstop (NASDAQ: WING), which are up 138% and 80% from their IPO pricings, respectively.

The Pet Health-Food Craze

Healthy foods have become quite the rage, including for pets. Blue Buffalo offers premium cat and dog food with fruits, veggies, meats and natural ingredients.
The premium pet food sector is the fastest growing segment of the pet food industry. Premium pet food sales were up 14% last year, while the rest of the pet food market grew 1%.
Annual pet food sales in the U.S. have almost doubled since 2000 and nearly hit $23 billion last year. The bulk of that is going toward premium pet food, which accounted for $10 billion in annual sales last year. In an interesting survey, research firm Mintel found that nearly 80% of U.S. pet owners deem the quality of their pet food to be as important as their own food.

The Pure-Play Advantage

Blue Buffalo is also a pure-play company. Other major pet food brands are wrapped up in larger food conglomerates, with Pedigree owned by Mars Inc. and Purina owned by Nestle SA (OTC: NSRGY).
The J.M. Smucker Co. (NYSE: SJM), which is known for its Jif peanut butter and Folgers coffee, spent nearly $6 billion to buy up the maker of Milk-Bone dog biscuits – Big Heart Pet Brands – earlier this year.
The key is that you won’t get a double-digit return on invested capital, like that of Blue Buffalo, by investing in Smucker or another conglomerate.
With a price-earnings ratio of 55 and a price-sales ratio of nearly 6, some investors will shy away from Blue Buffalo. But there’s something to be said for pure plays, especially in niche markets, where premium valuations aren’t uncommon.
Let’s have a look at some other companies in niche markets. First, there’s pet pharmaceutical player Zoetis (NYSE: ZTS), which trades at a P/E ratio of over 40. Niche beverage company WhiteWave Foods (NASDAQ: WWAV) trades at a P/E of just above 60. And then there’s niche health food company Hain Celestial Group (NASDAQ: HAIN), which has a P/E of 53.
Another key is that niche and premium products can demand above average margins. Both Blue Buffalo and Zoetis enjoy double-digit profit margins.
We’ve seen big valuations in the past, but certain companies have the opportunity to grow into these seemingly high valuations. Blue Buffalo certainly has those opportunities, and appears to be in the early innings of a pet food health boom.
If you think IPOs are hot, wait until you discover the world of pre-IPOs. Off-limits to all but the wealthiest investors, we’ve discovered three simple ways you can profit from these secret deals. Click here to find out how.

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