Penford Barks Up New Tree Entering Pet Food Market

Consumers have a hearty appetite for safe and healthy pet products. Penford (NasdaqGM: - ) is poised to tap into that need in big way.

Penford makes carbohydrate-based specialty starches used for industrial and food applications. It uses corn, wheat, potatoes and tapioca to produce specialty ingredients.

About half of its business comes from its Penford Products arm, which makes modified starches for paper, adhesives and textiles.

A second Food Ingredients unit sells starch-based coatings and binders to food and restaurant markets in North America.

After making its mark with products that enhance food for human consumption, the unit is using its know-how to develop and manufacture the starch component used in the recipe for pet treats and chews. Treats are bite-sized rewards, while chews are consumed over three to six minutes.

In addition to making the starch component, Penford will manage manufacturing, assembling, packaging and logistics to complete the production of the treat or chew products for customers on an outsourced basis. Customers are makers of pet food or products.

Malkoski sees lots of potential in this new market: "When we enter segments like this, we expect to develop significant business," he said.

Its initial offerings, which were introduced in April, are for dogs. But Malkoski sees a big opportunity in developing products for other pets as well.

The new products feed into the growing demand for safer pet products that offer health benefits, Malkoski says. The materials used in Penford's products dissolve well, an attribute that addresses pet owner concerns that some treats and chews break off in the animal's mouth and don't dissolve.

In the past few years, there have been cases where products have caused serious harm to dogs because they didn't dissolve and got caught in the intestine, adds analyst Jonathan Lichter of Sidoti & Co.

Nonallergenic Formulas

Another plus: Penford's products are nonallergenic because they are not made from wheat-based materials, to which some pets are allergic, says Malkoski. Its products are made out of materials such as tapioca, with formulations that are specific to Penford.

Consumers are skittish about wheat-based pet products in the wake of the animal deaths this year resulting from pet food made from contaminated wheat gluten.

Lichter says the pet industry could represent a big opportunity for Penford, though it's too early to know how much.

"It's really hard to tell at this point 15w large it could be," he said.

Malkoski sees an opportunity to enhance nutrition with the types of starches and ingredients used in its treat and chew products.

"Solving the dissolution and allergy issues are just a starting point," he said.

He foresees the ability to offer health benefits with these products.

Benefits may include making the products with ingredients that enhance an animal's coat or help the animal's dental care, Penford's Chief Financial Officer Steven Cordier says.

Penford's entry into the pet industry is important for its Food Ingredients unit for a few reasons, Cordier says.

It reflects Penford's ability to move into complementary marketplaces, he says, pointing out that Penford has transferred knowledge developed on the human side of the business into a related market.

The move also expands the unit's pipeline of new product introductions, which is the core of the ingredients business, he adds.

Cordier sees a lot of potential in pet products: "We think this is a great end market and a big market," he said. "There's a lot of room for the specialized products we offer."

Penford produces most of the pet product formulations in its existing food plant. It also is working with partners that already make these types of products to make some new formulations.

So far, the pet products have gotten a good reception, and Penford has landed several customers in this area, Malkoski says.

The move into pet products came less than a year after Penford entered another fast-growing area -- the ethanol market. In June 2006, it announced plans to invest $42 million in gear that will let its Cedar Rapids, Iowa, plant produce between 25 million and 40 million gallons of ethanol a year.

Penford's move into ethanol, which is made from corn, is a natural progression. Penford uses a lot of corn to develop its specialty starches. The company already has much of the infrastructure in place to produce ethanol with sufficient grain handling, separation processes, utilities and logistics capabilities.

To make ethanol, the industrial starch is cooked, fermented, distilled and dehydrated. Penford is investing in gear, such as fermentation equipment, to produce ethanol.

"It's our belief that ethanol is a vehicle that will help us accelerate our shareholder value," said Malkoski.

It diversifies Penford into an additional end market. And it adds manufacturing output to the Cedar Rapids site.

In the future, the fermentation process of ethanol production will enhance Penford's ability to make other high value chemical products, mainly for industrial use, says Malkoski.

Ethanol production will be ready for start-up at the end of December, Malkoski says.

Penford has been doing well with its current lineup. In the fiscal third quarter earnings more than doubled from the prior year to 54 cents a share. Revenue rose 21% to $95.4 million.

Improved Quality

Penford's starches are designed to enhance the quality of various end products. The most common use is strengthening and improving the quality of paper products. Penford's products also add manufacturing efficiencies to the production process.

The company's industrial ingredients business, which produces starches for the paper industry, benefited from prices increases, says analyst Waltzer.

One reason it's been able to fetch higher prices has to do with the fact that as speciality starch companies have moved into producing ethanol, it has taken some of the starch capacity from the market, he says.

"The supply of starrier is shrinking, which is good for Penford," he said.

Penford also is getting a lift from the fact that customers are running their machines at high capacity, Malkoski says. As a result, they're using more modified starches such as those made by Penford. Modified starches allow the machines to run faster and longer than unmodified starches, he says.

Penford's Food Ingredients unit continues to show good growth, says Malkoski. Ingredients used in processed meats to provide texture and juiciness have done well as have products used as a binder in meats such as chicken.

The two analysts polled by Thomson Financial expect earnings for the full year, which ended in August, to more than double to $1.56 a share, then rise another 39% in fiscal 2008.