Could China's pet market sustain double-digit growth in 2022-30E?
We base our analysis on the historical development of the Japanese market, which has similar demographic trends to China, such as a declining birth rate and ageing population, and therefore acts a useful guide to assess how the China pet sector may evolve. In our view, we believe China's pet market has substantial growth potential supported by rising pet ownership, sub-sector diversification and consumption upgrade. We estimate the industry could expand at a 12.9% CAGR to Rmb756.5bn over 2022-30E and expect the sector to deliver a 2023-25E EPS CAGR of 28%, i.e., more than triple of its global peers. We think the current valuation underestimates the pet market's resilience against an economic downcycle and overlooks the substantial growth from the 'cat economy' and diversifying into other pet business categories. In China, pet cats outnumbered pet dogs for the first time in 2021, reflecting the lower time, living space and financial demands of keeping a cat versus a dog, similar to what has taken place in Japan. Going forward, we think the 'cat economy' will likely be the main growth driver of China's pet market.

Strong resilience and growth potential, despite COVID
China's economy slowed during the COVID pandemic in 2019-22, however the pet sector has shown resilient post-pandemic growth supported by rising pet ownership and increasing per-pet spending. ÃÛ¶¹ÊÓƵ Evidence Lab's survey of over 1,500 Chinese pet owners suggests nearly 80% of the respondents maintained or increased their pet-related consumption after the pandemic versus before the pandemic, providing evidence of the pet market's strong resilience in the face of macro headwinds. Among the various sub-sectors in China, pet food sales delivered a 14.3% CAGR over 2019-22 during COVID, 2.6ppts higher than overall industry revenue, accounting for 41% of overall pet spending in 2022, up 2ppts from 2019. We attribute such resilience to the significant role that pets can play in households. According to Asia Pet Alliance (APA) Institute, nearly 90% of the households it surveyed regarded pets as important family members. We believe pet humanisation trend is a key driving force for the industry.

Opportunities/challenges to become domestic market leaders
While China's 'cat economy' has developed quickly, there remains a lack of domestic staple cat food brands with a clear lead. We believe early entrants to the 'cat economy' that have got a head start in building brand awareness in the cat food category, along with Chinese pet food companies with a strategic focus on economies of scale in production and penetration of advantageous local channels, are better positioned to benefit from industry growth and achieving market share gains. Chinese companies have four key challenges to become domestic market leaders:

1) identifying and seizing new market trends (such as the burgeoning 'cat economy' in China);

2) developing in-house production capacity to ensure products are of a consistently high quality;

3) leveraging advantageous local sales channels; and

4) cultivating strong R&D capabilities to facilitate product diversification to meet different consumer groups' needs.

While overseas demand recovers, the focus is likely to be on domestic growth
China's pet industry performance is highly correlated with overseas demand and FX, with exposure to external markets at over 70% in 2022. The sector index corrected in September 2022 and has remained depressed as overseas demand has weakened. However, we think decelerating overseas growth has been priced in now and note a gradual recovery in export orders since April 2023. Moreover, with domestic pet food names expanding their localÌýmarket presence, we believe the rationale driving sector valuation is being reshaped, with investors' focus shifting back to domestic growth. Looking ahead, we believe there remains significant room for growth in China's pet market, as it has been relatively late in developing versus the pet market in Europe, the US and Japan. While the pet food sub-sector is relatively mature, accounting for 41% of overall pet industry sales in 2022, given it has relatively low barriers to entry and provides staple goods, the market for pet medical care, pet medicine and pet insurance remain in the early stage of development in China, suggesting there is significant growth potential.