FRESHPET, INC.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Freshpet, Inc. is a pet food company manufacturing and distributing fresh, refrigerated food and treats for dogs and cats.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Freshpet, Inc. is a pet food company that operates in the rapidly evolving pet food market, focusing on fresh, refrigerated products. The company’s core mission is to provide nutritious food for dogs and cats. It aims to differentiate itself by offering high-quality, fresh ingredients as a superior alternative to conventional dry pet food.

Freshpet’s products are sold under its brand name, and are targeted to pet owners who prioritize the health and well-being of their pets.

Revenue Streams:

  • Grocery, Mass, International, and Digital: Primarily from sales of pet food products through retailers like grocery stores and distributors. It seems like net sales increased year-on-year.
  • Pet Specialty and Club: Primarily from sales of pet food products through stores that specialize in pets and those through club stores. It seems like net sales increased year-on-year.

The pet food industry is characterized by several trends:

  • Increased Humanization of Pets: Pet owners are increasingly treating their pets as family members and seek high-quality, fresh, natural food options, leading to a growing demand for premium pet foods.
  • Health and Wellness: Concerns about pet health are driving increased demand for foods with natural ingredients, high nutritional content, and specific health benefits.

This trend towards premium pet food is beneficial to Freshpet.

  • Shift to Fresh/Refrigerated Foods: Increasing awareness about the nutritional shortcomings of processed foods is boosting the appeal of fresh, refrigerated pet food.
  • Growth in E-Commerce: Online shopping for pet food is rising, offering significant opportunities for companies to reach more pet owners.

Competitive Landscape:

Freshpet operates in a competitive landscape with large conventional dry pet food companies, new fresh pet food brands, smaller niche brands, and private-label products from major retailers. While companies like Nestle, Mars, and J.M. Smucker dominate the industry, they focus mainly on the “dry pet food” segment. There are competitors, who are focusing on the fresh food segment, like Ollie and The Farmer’s Dog.

What Makes the Company Different:

Freshpet differentiates itself by making a commitment to fresh and nutritious food made from a combination of fresh meats and vegetables, as well as minimal processing.

  • Fresh and Refrigerated Format: The unique selling point of Freshpet is its fresh, refrigerated format, which differentiates itself from the conventional dry pet food.
  • Brand Focus: Freshpet has built a brand that resonates with health-conscious and pet-loving customers.
  • Focus on Transparency: The company also emphasizes its commitment to using human-grade ingredients.

Financial Analysis

Revenue Growth: Net sales increased 16.8% to $253.3 million for the three months ended September 30, 2023, compared to $216.8 million for the three months ended September 30, 2022. Net sales increased 26.3% to $765.4 million for the twelve months ended December 31, 2023, compared to $605.2 million for the same period last year.

Net sales growth was driven by increasing awareness of the product, pricing actions, and the growth of Freshet Fridge locations.

Gross Profit & Margins: Gross profit for the three months ended September 30, 2023, was $90.5 million, or 39.6% of net sales, compared to $72.9 million, or 33.6% of net sales, for the three months ended September 30, 2022. Gross profit for the twelve months ended December 31, 2023 was $272.8 million compared to 180.9 million for the prior year. Gross profit margin has been increasing, as pricing actions have improved profitability, as well as increased sales.

This shows that Freshpet is able to gain more money from each sale of its products. Operating Expenses: Selling, general, and administrative expenses for the three months ended September 30, 2023, were $78.7 million, or 34.6% of net sales, compared to $61.6 million, or 28.4% of net sales, for the three months ended September 30, 2022. Selling, general, and administrative expenses for the twelve months ended December 31, 2023, were $271.8 million compared to $221.5 million for the same period last year. These expenses are elevated as the company focuses on growth. The adjusted SG&A, as a % of net sales, was 38.4% in 2022 and 36.1% in 2023, so a positive trend is observed.

This shows that these expenses are growing slower than sales, leading to economies of scale. Income and Profitability: Net income (loss) for the three months ended September 30, 2023, was $11.1 million, compared to a net loss of $(7.8) million for the same period in the prior year. For the twelve months ended December 31, 2023, the company posted a net income of $30.6 million compared to a net loss of $56.7 million for the prior year.

This is a strong indicator that the company’s financials are getting better. Cash Flow: The cash flow from operating activities has become positive for Freshet at $39.9m for 2023. Capital expenditure remains elevated at $96m. Free cash flow remains in the negative but showing a positive trend. Balance Sheet: Freshpet has $212.9 million in cash and cash equivalents as of September 30, 2023. Long-term debt outstanding is $339.7 million. However, this does not look like a big problem as the company is able to generate good revenue and profits from its operating activities.

Moat Analysis

Based on the latest information, Freshpet’s moat is assessed as follows:

  • Intangible Assets (Brand): Freshpet has built a strong brand, particularly within the fresh pet food category. While the company’s marketing is effective, it’s not clear if the brand commands the same price premium as certain leading consumer goods brands.
  • Switching Costs: The switching costs for pet food are low, especially compared to products like software. Consumers can easily switch from one brand to another with little friction, meaning there’s low loyalty and pricing power of Freshpet.
  • Network Effect: The network effect is not a major component of a company selling pet food, but may impact the growth of specialized channels through which Freshpet sells its products. The more stores that distribute the brand, the more it benefits the company. This may be considered as a positive, but not substantial, advantage.
  • Cost Advantages: It does not seem like Freshpet has large cost advantages at this time. The company is a high-quality food manufacturer, and this usually translates to higher input costs. The company focuses on the use of natural, human-grade ingredients which come at a premium. Therefore, we do not think they have a major cost advantage right now. Moat Rating: The above analysis suggests that Freshpet is unlikely to have a wide moat. The company has a small advantage in intangible assets and some minor switching costs. I give Freshpet a 2/5 rating on the moat due to these factors.
    • The company has had moderate success in its focus on making a specific category, but overall, the company struggles in its financials.

Risks to Moat and Business Resilience

  • Competitive Threats: It is likely that competitors will continue to imitate Freshpet’s models. The brand is also susceptible to marketing campaigns that can cause a shift in customer preferences.
  • Supply Chain Issues: Reliance on a limited number of suppliers or any issues with the supply chain may disrupt operations and increase costs.
  • Changing Consumer Preferences: The pet food industry is subject to changing preferences, and customers may prefer pet food that does not align with Freshet’s strategy.
  • Economic Downturns: An economic downturn may affect consumer spending on premium products and reduce the company’s revenues.
  • High valuation, despite lack of profits: The company’s stock is expensive even after adjusting for growth, which is a potential downside risk.

It is hard to justify a premium value without proven sustainability of returns on capital.

Despite these challenges, Freshpet’s focus on a new segment and the ability to innovate give it a moderate resilience. It is also showing positive movement on profitability.

Understandability:

While Freshpet’s business model is based on something every consumer already knows, the financials are much harder to track, as well as their strategy. For this, I give a rating of 2 / 5.

Balance Sheet Health:

Freshpet is not in a perfect place when it comes to its balance sheet. Debt levels are somewhat high, however the company’s financials are improving. For this, I give a rating of 3 / 5.

Recent Concerns/Controversies/Problems

In their latest conference call, they said that their revenues were lower than expected, which caused a sell off in the stock. They blame it on the macroeconomic slowdown and low demand, but also a bit of overstocking from competitors and lack of marketing from Freshpet itself. They have responded to this by taking steps to increase demand and reduce costs, such as cutting SG&A expenses.

While there are some concerns about short-term performance, they are taking steps to become more sustainable. The long-term picture of the company is still positive, as it expands its brand and increases awareness of the importance of fresh pet food, while also improving internal efficiency.

They were also accused of misselling their products in the past, by not specifying clearly that the product must be stored in a fridge, however this lawsuit was settled in court.

Overall Conclusion

Freshpet is trying to establish a dominant place in the fresh and refrigerated pet food market. Though the industry is on the rise, the company faces strong competition. It has shown some promise in its top and bottom line, however risks are apparent and must be closely watched before making any investment decision.