Passing on Freshpet and Several Others

I wanted to take a moment to share some research on a relatively new addition to the Green Screens, Freshpet (FRPT).

You have probably seen Freshpet coolers showing up at your local grocery store or Walmart. The company makes, markets, and distributes pet food made from fresh meat, vegetables, and fruits farmed by and made at Freshpet facilities. Their products - like "Deli Fresh Grain Free Chicken for Dogs", or "Vital Grain Free Chicken and Ocean Whitefish for Cats" - are then rolled, shipped, and stored refrigerated, maintaining their freshness.

Certainly there are things to like about the business. The trend (particularly in the U.S.) of treating pets as equal members of the family has been accelerating for decades. What better care could you take of your dog or cat than to feed them fresh, minimally processed, healthy food? Freshpet has ridden this trend to a 5 year compound annual revenue growth rate exceeding 30%, that shows no signs of slowing (the firm produced 32% growth in its most recent quarter).

This growth has the potential to be long-tail, too. The U.S. pet food market is pretty darn big, at $58.5 billion in 2024, growing near 6% annually. Compare that to Freshpet's run rate of about $750 million in revenue, and we see that the firm has only 1.2% market share. That leaves quite a bit of room for market share gains over the next decade and beyond. Growth potential is not an issue here.

The distribution model also sets up Freshpet for a potential "unique asset" moat. For obvious reasons, supermarkets are not going to stock pet food in the same fridges as human food. At the same time, it is highly unlikely that those same stores are going to be willing to dedicate space to more than one fresh pet food vendor. That means, once Freshpet establishes a fridge in a location, there's a good chance it is "locking in" the fresh pet food sales from that location for itself. With close to 25,000 fridges in operation, Freshpet is establishing unmatched scale in this category - scale that locks out prospective competitors.

So, things look pretty good up to here, so why is this stock a "pass"?

The reason is simple - it just isn't a very attractive business from a profitability or cash flow perspective. Freshpet has never delivered a net profit, and free cash flows have dwindled from tiny (2.3% margin in 2018) to non-existent (cash flow negative in '21 and '22, close to break-even in '23).

Now, some of this we can excuse as growth investments, but metrics aren't getting a whole lot better. Gross margins have plummeted from 46.6% in 2018 to 30.9% in the past 12 months. Debt has gone from nothing in 2018, to close to $400 million today. Share count has increased by an average of 8% annually. Nothing here gives me confidence that (a) this is a lucrative business model or (b) Freshpet is particularly well-run.

With so many other great companies in our screens, that's really as far as I need to go before giving the "pass" to Freshpet.

Passing On A Few Other Stocks In Areas We've Looked At Before

I mainly wanted to share my thoughts on Freshpet, but we might as well also quickly reject some other new-ish screen stocks that fall into categories that have been rejected before.

Allstate (ALL): A property/casualty insurance firm (why we passed).

Banco Macro (BMA): A regional bank (why we passed on them).

Live Oak Bancshares (LOB): Another regional bank.

Skyward Specialty (SKWD): Another property/casualty insurance firm.

Rover Group (ROVR): An online marketplace for pet care services, Rover group was acquired by Blackstone back in November for $11. With the stock trading almost right at that price, there is no upside here.