Practical analysis for investment professionals
12 September 2013

Are Pets Replacing Children in Japan?

Posted In: Drivers of Value

Once upon a time, Japan boasted one of the lowest divorce rates in the world. However, over the past two decades, divorces have escalated sharply. According to statistics from Japan’s Ministry of Health, among the 708,000 couples that were married in 2010, 253,353 had filed for a divorce. The ministry also released survey results that showed that divorce rates in 2009 were up 3.9-fold from 50 years ago. This coincides with the further drop in birthrates the country has seen over the past few decades. Interestingly, pets are rapidly becoming the center of attention and companionship within the Japanese household. Official estimates show that the national pet population is over 22 million, compared with only 16.6 million children under the age of 15. Are these trends just a coincidence, or are children really being replaced by pets in Japan? Is there a legitimate correlation between divorces and the proliferation of pets in the average household? Perhaps more importantly, will fertility rates in Japan ever rebound in the future?

As an investor, the more relevant exercise would be to interpret these trends from an economic standpoint. Admittedly, Japan does not boast the highest absolute number of pets worldwide, nor even on a pet per household basis. On a sheer size basis, the US is the largest pet care market by a wide margin. However, the pampering of pets and the discretionary spending on pets has been reaching unprecedented heights. For example, it is reported that some dogs in Japan have their own rooms and wardrobes full of designer clothes, including such brands as Hermès, Gucci, and Chanel. With dresses, jewelry, sunglasses, and even diapers, these pets are truly living a pampered life. In certain areas in Tokyo, it is sometimes easier to find a boutique apparel outlet for pets than for children. Pet hotels, spas, and yoga lessons, or “Doga,” are also among the other luxuries available for pets in Japan.

Admittedly, it is true that one can cherry-pick extreme anecdotes from almost anywhere around the world. But it is undeniable that discretionary spending on pets, particularly outside of traditional areas such as standard pet food, is in structural upturn within Japan. By way of background, the pet care industry is broad based and includes such segments as mainstay food, health care, and products used during the grooming, breeding, and selling process. New markets, such as gourmet and “holistic” foods that use raw meat, are also beginning to gain traction. According to the Ministry of Internal Affairs and Communications, these products have helped catapult the pet care industry to well over ¥1.2 trillion in annual sales.

The four major trends that are driving Japan’s pet industry include:

  • keeping pets indoors,
  • people preferring smaller dogs,
  • increasing pet lifespans, and
  • rising rates of pet obesity.

In a survey conducted in 2012 by the Pet Food Institute of Japan, 24.9% of domestic households live with either a cat or dog. Because the survey did not include homes with other pets, such as hamsters, rabbits, and birds, it is likely that the proportion of households living with animals is actually much higher. With regard to the first driver, the proportion of dogs kept indoors has risen to 70% and to 90% for cats. In a nation where real estate is scarce and population density continues to be on the rise, it is likely that these trends will continue. As Japan’s society has steadily aged over the years and as more pets have migrated indoors, the preference for smaller and more manageable dogs has also unsurprisingly risen. Although this trend has naturally put pressure on mainstay pet food sales, demand for specialized foods, toiletries, and disposable diapers is rising rapidly. It seems pets are also aging alongside their masters. The average lifespan of dogs has risen — from 7.6 years in 1985 to 15 years by 2003, spurring more demand for pet healthcare services. Concerning obesity, in a survey conducted by the Japan Pet Food Manufacturers Association, 21% of dogs were considered “somewhat chubby,” whereas 28% were labeled by their own owners as “outright fat.” To tackle this ever expanding (literally) trend, new products related to pet nutrition and fitness have also emerged. While obesity levels are actually higher in other countries, the world’s first dog pedometer went on sale in Japan towards the end of 2012.

This unique demand has attracted multinational players from around the world. The top three include Mars Petcare (a private company, with such brands as Pedigree, Caesar, Kal Kan), Unicharm (ticker: 8133 JP, with such brands as Neko Genki and Gin no Spoon), and Nestlé Purina (ticker: NESN.VX, with such brands as Friskies and Mon Petit). Generally speaking, the largest companies, especially the foreign players, have been slow to adapt to the changing trends seen in Japan. They face challenges to their traditional brands due to increasing market segmentation and demands from the consumer for increasingly specialized and premium products. In addition, these players are facing more price competition as the internet becomes an important sales channel for the industry. Domestic Japanese firms, or foreign companies with Japanese manufacturing facilities, have also had a leg up in recent years because of worries about product safety, with consumers preferring pet food that is made in Japan. All in all, the future of Japan’s pet care industry is up for grabs for the company that can aggressively meet this under-serviced demand.

As an equities investor, it is unfortunately more difficult to capitalize on these trends specific only to Japan, as most stand-alone, publicly listed pet care companies have quickly been devoured by larger players hungry for this rapid growth. Unicharm would still provide the largest exposure to this market however, with roughly 15% of its sales coming from its pet care operations. The good news is that these trends are also occurring in many other areas through in the world, particularly in the US. Although not as concentrated and compelling from an investment standpoint, the US pet care industry has been growing at a steady 5% CAGR for the last 5 years, and is estimated to reach $55.53 billion in 2013, according to estimates given by the American Pet Products Association. One listed play that stands out is PetSmart (ticker PETM US), a specialty retailer and operator of pet superstores and pet hotels in the US and Canada. The company also offers pet training, grooming, boarding, and adoption services among other products. PetSmart is trading at 17.5x forward P/E, virtually zero net debt, and is conservatively projected to grow profits by over 10% over the next 3 years, according to Bloomberg consensus estimates. Other candidates include VCA Antech (veterinarian centers, ticker WOOF US), Neogen (pet safety products, ticker NEOG US), and PetMed Express (pet pharmacies, ticker PETS US).

Japan’s pet care industry is in a structural upturn, which arguably is coming at the expense of the structural downturn in the nation’s population and birthrates. So is it fair to say that children, husbands, or wives are being replaced by the companionship that Lassie, Benji, and Toto bring to the table? Perhaps. But who is to judge whether the people of Japan should have more children or fewer pets in the first place? Maybe the trends being witnessed demonstrate a move closer to the society’s natural state of equilibrium. After all, Japan still has some catching up to do to reach the pet per household levels we see in the United States or even the United Kingdom. Whatever the reason may be, we should strive to learn from these trends. In doing so, there is a lot of money that is up for grabs for anyone who is willing to embrace this phenomenon. The two options are to either sit on the sidelines or participate as an investor or direct market participant. Structural upturns are not meant to last, and they are usually accompanied by a significant level of market inefficiency. Whichever you choose, someone out there is going to make a whole lot of money.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

About the Author(s)
Daniel Kim, CFA

Daniel Kim is founder and chief investment officer at Blackcrane Capital, an investment management firm based in Bellevue, Washington. Previously, he was a portfolio manager and partner at Mastholm Asset Management.

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