First Look: Zoetis
As investors, we always like to identify trends happening in the world around us. Most are obvious: cashless payments, the rise of cloud computing, electric cars. However, one underlying global megatrend we love to track here at MyWallSt is the rise of pet care.
This was already a craze long before COVID-19 became an everyday reality, but lockdown certainly sped things up. According to the American Society for the Prevention of Cruelty to Animals (ASPCA), more than 23 million American households — nearly 1 in 5 nationwide — adopted a pet during the pandemic.
And as the saying goes, these pets are for life, not just for C
hristmasOVID. In fact, 91% of U.S. "pet parents" consider their pets to be family members and 81% consider them as equal members of the family.
This all means big business for the companies involved in the industry. Fortune Business Insights has the global pet-care market set to grow at a 6% CAGR to $326 billion by 2028. A company I’ve highlighted to take advantage of this growing market is Zoetis.
Zoetis is the world’s largest animal-care company. It manufactures medicine and vaccinations for pets and livestock. Initially a subsidiary of Pfizer called Pfizer Animal Health, it was spun off in 2013 to become its own independent company. It serves two major markets — companion animals (pets) and production animals (livestock). Companion animals make up about 64% of total revenue, while in the U.S. they account for 76%.
The company boasts a dominant market position in companion animals, cattle, fish, and pigs and 13 of its products generate more than one-third of total animal health sales. Constantly innovating, the company has introduced close to 1,000 new products and updates to existing products over the past five years. Products range from parasitics, dermatological products, arthritis treatments for cats and dogs, and respiratory antibiotics in cattle, to name a few.
There is a lot to like about Zoetis’ business model. The purchasing power in the animal space is a lot more fragmented than in human care, with the absence of government payers or larger managed care firms and health insurance companies. Buyers instead are farmers, vets, and pet owners, meaning Zoetis enjoys more pricing power. Its scale and existing relationships become much more important in a fragmented buyer market too, giving it a competitive advantage over new entrants.
It is geographically diversified, with roughly half of its revenue coming from international operations. It is also female-led, with CEO Kristin Peck coming over from Pfizer when the company was spun-off. And this Pfizer level of expertise can’t be underestimated, as the processes and protocols from one of the world’s most successful pharmaceutical companies are ingrained into the culture of Zoetis.
One thing worth highlighting is that the companion market is growing faster, enjoys greater margins, and has fewer outside threats — discussed below — than the production animal sector. Because of this, the company has brought in a new go-to-market strategy in April of 2022 that involves expanding its salesforce in the U.S. by 40%.
All of these advantages show up on the balance sheet. At a market cap of $77 billion, Zoetis is a beast. It has guided for revenue just shy of $8.5 billion this year and net income of around $2.4 billion.
It has an excellent margin profile, with 82% gross margins from its U.S. operations in the first quarter of this year — where pet care makes up the majority of revenue — and 72% from international — where pet care and livestock are evenly split. While it has almost $7 billion of debt on its balance sheet, considering its $3 billion cash position, and the fact that this company is generating cash hand over fist — $1.7 billion in free cash flow last year — this isn’t any major concern.
It is also redistributing this cash to its shareholders in the form of a $1.30 annual dividend and a share repurchase program of $3.8 billion.
Like most high-quality businesses, a premium valuation is not far behind. With a price-to-earnings ratio of about 38, this is a pricey stock, especially considering its growth rate is hovering around the low double-digits. Valuation compression in the future is a very real risk, and it’s not the only one.
There is a regulatory risk overhanging the livestock side of the business as antibiotic usage in production animals finds itself under the microscope. Consumers in western markets are also trending toward more organic farming methods and cutting out meat from their diets. However, this latter point will be counteracted by increased protein consumption in emerging markets.
Lastly, we come to patents — the perennial opportunity and threat that hovers around all pharma businesses. 20% of Zoetis’ revenue comes from patent-protected products. While this prevents competition and affords pricing power, it also opens itself up to risks down the line. Once these patents expire, generics can enter the market, putting said revenue at risk. This is happening right now with its antibiotic Draxxin, which is experiencing a decline in sales after its patent expired in 2020.
Zoetis is a complex business with a number of clear risk factors attached. However, it is also a market leader in an exciting, growing industry. I’m looking forward to getting in the weeds with this one as I think it could spell an exciting opportunity in tough market conditions.