A menagerie of new products are available to treat itchy skin, influenza, weight loss, and pain. They are aimed not at you, but at your pets.
Not only is pet ownership widespread—about 57% of U.S. households owned a pet in 2016, according to the American Veterinary Medical Association—but dogs and cats are also living longer and are being treated more like humans by their owners in terms of medical care.
“We went from pets on the farm to pets in the house to pets in the bed,” says Clint Lewis, who heads international operations at Zoetis (ZTS), the largest public animal-health company. “As our human population grows, it also ages, and with that comes an increased recognition of the importance of companionship.”
Last year, U.S. pet owners rang up an estimated $15.5 billion on over-the-counter medicine and supplies, more than double $6.2 billion in 2001, says the American Pet Products Association. That’s only a portion of what was spent on animal health.
The surge in pet sales is leading growth overall in the $36 billion global animal-health market. The biggest sector, livestock—medicines, vaccines, and medicinal feed additives for cattle, poultry, swine, and other animals—accounts for two-thirds of the market, while pets make up the remainder.
The global animal-health industry is projected to grow at a 5% compound annual rate from 2017 to 2023, according to Vetnosis, a consulting firm.
Kevin Ellich, senior research analyst at Craig-Hallum Capital Group, a research, trading, and investment banking firm, largely concurs, expecting mid- to high-single-digit annual growth for the pet business, faster than the livestock business.
The livestock business boils down to feeding more people as they become wealthier and eat more meat.
“There is a growing demand associated with the growing middle class, particularly in emerging markets, for greater protein consumption,” says David Risinger, an analyst with Morgan Stanley.
At the same time, the steady increase in pet spending isn’t exclusive to the U.S. For Zoetis, two of its fastest-growing markets are China and Brazil, where “not only are they growing in pet ownership, but also in their level of care,” Lewis says.
In China, the company’s pet revenue totaled about $84 million last year, up 47% from $57 million in 2017.
For investors wanting to play this growth directly, the opportunities are limited and pricey.
In the case of Zoetis and rival Elanco Animal Health (ELAN), investors have been paying up for durable sales growth and reliable earnings. Even a much smaller company, Phibro Animal Health (PAHC), fetches 19 times what it’s expected to earn in its current fiscal year ending in June.
Zoetis has had an annual return of 25% since it was spun off from Pfizer (PFE) in early 2013, compared with 11% for its former parent. A major question is whether it can sustain such a strong pace of returns.
Elanco stock, part of Eli Lilly (LLY) for many years, has gained 35% since it was priced at $24 in an initial public offering in September.
Bayer (BAYRY) is looking to sell its animal-health business. Merck (MRK), however, hasn’t shown any signs of separating its $4.2 billion unit. On a call with analysts last year, CEO Kenneth Frazier said that the business provides important revenue growth and diversification.
The other large top five player, Germany-based Boehringer Ingelheim, is privately held.
Zoetis, at around $99, trades at a little more than 28 times the $3.47 a share analysts expect it to earn this year. Elanco fetches an even higher multiple, at 30 times its consensus 2019 profit estimate of $1.09 a share.
Yet there’s plenty to like about the animal-health business, starting with mid-single-digit annual sales growth. And margins are strong. Last year, Zoetis had a net margin of a little more than 24%, more than double what it was in 2013.
John Kreger, a William Blair analyst, expects Elanco to increase its operating margin to the low- to mid-20s over the next few years from about 18%.
Health care for animals has certain advantages over health care for humans. The industry doesn’t have to contend that much with pricing pressure from insurance companies, as most medical expenses are paid out of pocket. Although more pet insurance is becoming available, it’s not widely used just yet.
Developing drugs for pets, compared with for humans, “is generally faster and less expensive, since it requires fewer clinical studies involving fewer subjects,” Kindred Biosciences (KIN), a small animal-health biotech company, noted in a filing.
The company tries to find compounds that have worked in humans so “we don’t have to start from scratch,” says Richard Chin, Kindred Biosciences’ CEO.
Generic drugs are less of a threat, as well. “The economies of scale are much more difficult to generate in an industry in which a blockbuster is $100 million,” Juan Ramon Alaix, the CEO of Zoetis, tells Barron’s.
To be sure, these companies haven’t come up with many game-changing drugs for animal cancer treatment, for example. In fact, veterinarians sometimes use human drugs to treat that disease.
Still, plenty of new products focused on animals have been rolling out. These include treatments for dogs with itchy skin or parasites; cattle with bovine respiratory disease; cats with unintended weight loss; and dogs with pain issues.
“We didn’t even think about pain medication in the ’70s,” recalls Dr. David Bjork, a veterinarian in Walnut Creek, Calif., who started practicing in 1969.
Scientists are now taking more sophisticated looks at “the cause of a condition,” and they have been able to develop new approaches, says Catherine Knupp, who heads research and development at Zoetis.
For example, in 2016, the company won approval to launch Cytopoint. Known as a monoclonal antibody, Cytopoint treats atopic dermatitis, including itching in dogs. This therapeutic drug, which is injected, uses antibodies to target and neutralize canine IL-31, which sends signals to itch to a dog’s brain.
Sometimes innovations are much simpler.
As many pet owners can attest, keeping track of their dog’s monthly flea, tick, and heartworm disease regimen can require a spreadsheet. One pill is for fleas and ticks, another for heartworm—but they may not be administered at the same time.
Zoetis is among those trying to roll out a product that includes all three treatments and others into a chewable pill administered monthly.
The livestock side of animal health, meanwhile, hinges on protein production, whether it is milk, cheese, beef, poultry, pork, or fish. It’s tied to global population growth and evolving palates, as the middle class expands, particularly in developing markets.
“Going from eating rice and grains to protein is something that occurs as economic growth ensues,” Risinger of Morgan Stanley says.
The medical treatment of livestock is changing as food companies move toward antibiotic-free beef, chicken, and pork. Perdue Foods, for example, raises most of its chickens under the label “No Antibiotics Ever.” In December, McDonald’s said it would seek to reduce the overall use of antibiotics in its beef.
“There has been a huge shift from a reliance on antibiotic treatment to relying on other forms of disease management and prevention,” says Jim Sandstrom, managing director of Epitopix, which makes vaccines for livestock production.
Better diagnostics, electronic tracking of herds, and genetic testing are also coming into the mix for raising livestock.
While livestock sales continue to grow, pet therapeutic sales, which skew heavily toward dogs, versus cats and horses, are more attractive.
“People are not all that price sensitive when it comes to their pets, compared with a generation ago,” Kreger of William Blair says. “You just don’t have that dynamic with livestock.”
A multibillion-dollar category for pet care is parasiticides, which control fleas, ticks, mites, and more.
Boehringer Ingelheim is a big player in this market. Merck has had success with Bravecto, which kills fleas and ticks in dogs and cats.
Previously, these products had to be applied topically; chewables are much more convenient for pet owners.
One of Elanco’s products in that category, Interceptor Plus, which wards off heartworm in dogs, reached $100 million of sales last year.
For all of its heft, Zoetis is playing catch-up in this category. Its portfolio includes Simparica, a once-monthly chewable flea-and-tick pill for dogs. To help it gain more market share, Zoetis hopes to introduce Simparica Trio, for flea, tick, heartworm, and other internal parasites, next year.
Zoetis has made a lot of hay with treating canine skin conditions, including atopic dermatitis. Apoquel’s sales totaled $464 million last year, up 28% from 2017. Cytopoint rang up $129 million in sales.
That kind of growth, combined with a solid management team, ample financial flexibility, and an effective R&D operation, make its stock attractive, even at a high valuation.
Alaix, the CEO of Zoetis, maintains that the company has “the financial strength to support our investment” and “the discipline to invest in the areas that will maximize the return and protect our long-term profitable growth.”
That includes parasiticides and dermatology drugs.
Historically strong in livestock, Elanco has been making inroads in pet therapeutics, which accounted for about a third of its $3 billion of sales last year. That includes Galliprant, an osteoarthritis drug for dogs, and Credelio, a canine flea-and-tick treatment.
Kreger of William Blair rates Elanco Market Perform and Zoetis Outperform. He maintains that Zoetis can grow its sales organically at an annual clip of 5% to 6% over the next four years, against 3.5% to 4% for Elanco, excluding businesses it is selling.
Elanco has said it expects to grow core revenue, which excludes businesses it exits, 4% to 6% this year.
Kreger gives the pipeline advantage to Zoetis, citing the recent success of Apoquel and Cytopoint. “A key unknown in the Elanco story is new product flow,” he says.
Colleen Parr Dekker, Elanco’s director of global external communications, says the company has been launching “approximately three new products a year since 2015.” That includes Interceptor Plus.
Investors, however, may want to wait for a better entry point.
For now, at least, Zoetis is firing on all cylinders, justifying the valuation of its stock.
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