Contents
Summary
- This company may not be a household name but it is building on more than 60 years of experience.
- It was part of a much larger pharmaceutical company but was spun off in 2013.
- Its acquisition strategy and new product development provides potential for growth in a multi-billion dollar global animal healthcare market.
- While the company’s dividend has evidenced double digit percentage growth, the dividend yield is sub 1% which may dissuade some investors from giving this company a good hard look.
- I view the current market price as being too rich at the moment.
Introduction
Many readers may be unfamiliar with this company yet it boasts some impressive statistics.
- Its products are sold in more than 100 countries and it has a presence in ~45 of these countries;
- There are 25 manufacturing sites in 12 countries;
- It has 300 product lines in 5 major product categories;
- Sales for its most recent fiscal year amounted to ~$5.3B;
- Its workforce consists of more than 9000 employees worldwide;
It is the world leader in the discovery and delivery of products and services in its field. This has not occurred overnight and, in fact, this company is building on more than 60 years of experience.
The company was formerly a business unit of a multi-national pharmaceutical company prior to incorporating in July 2012 and being spun-off as a publicly traded company in 2013.
This company has just recently completed a ~$2B acquisition of another company with complementary products. Management has now revised FY2018 revenue guidance to $5.7B - $5.8B.
Business Overview
Zoetis Inc. (NYSE: ZTS) was incorporated in July 2012 and prior to that the company was a business unit of Pfizer Inc.. For more than 60 years it has been committed to the discovery, development, manufacture and commercialization of animal health medicines and vaccines, with a focus on both livestock and companion animals. You can access an interactive timeline here to learn more about ZTS’s history. A corporate narrative is available in pdf format.
ZTS has a diversified business, commercializing products across 8 core species: cattle, swine, poultry, fish and sheep (collectively, livestock) and dogs, cats and horses (collectively, companion animals). It has 5 major product categories: anti-infectives, vaccines, parasiticides, medicated feed additives and other pharmaceuticals.
ZTS’s livestock products represented ~ 57% of FY2017 revenue and its companion animal products represented ~42%. The Client Supply Services (CSS) aspect of the business provides contract manufacturing services to third parties; this are generated ~1% of ZTS’s total revenue in FY2017.
The animal health medicines and vaccines market is characterized by the following meaningful differences in customer needs across different regions.
- Economic
- Cultural
- Epidemiological
- Treatment
- Environmental
- Regulatory
Due to these differences, ZTS is organized and operated in two segments.
- United States - $2.62B or 49% of total revenue in FY2017;
- International - $2.643B or 50% of total revenue in FY2017.
Source: ZTS - FY2017 10-K
Products are marketed in ~45 countries across North America, Europe, Africa, Asia, Australia and South America and its products are sold in more than 100 countries. Operations outside the US accounted for 50% of total revenue in FY2017. Brazil, China and Mexico, and other emerging markets contributed 23% of revenue.
In FY2017, ZTS’s top two selling products, Apoquel® and the ceftiofur line, each contributed ~7% of revenue, and combined with its next two top selling products, Draxxin® and Revolution®, these 4 contributed ~25% of revenue. The top ten product lines contributed ~39% of revenue.
Research and development (R&D) is an integral aspect of ZTS’s growth strategy; focus is on the discovery and development of new chemical and biological entities, as well as product lifecycle innovation. A substantial portion of the company’s products and revenue has been the result of product lifecycle innovation wherein ZTS’s R&D team works to broaden the value of existing products by developing claims in additional species, more convenient formulations and combinations, and by expanding usage into more countries.
ZTS pursues the development of new vaccines for emerging infectious diseases, with an operating philosophy of ‘first to know and fast to market’.
The R&D operations are comprised of a dedicated veterinary medicine R&D organization, research alliances and other operations focused on the development, registration and regulatory maintenance of ZTS’s products. ZTS incurred R&D expenses of $0.364B, $0.376B, and $0.382B in FY2015 – FY2017, respectively.
Livestock products are sold directly to a diverse set of livestock producers, including beef and dairy farmers as well as pork and poultry operations, and to veterinarians, third-party veterinary distributors and retail outlets that then typically sell the products to livestock producers.
ZTS’s companion animal products are sold to veterinarians or to third-party veterinary distributors that typically re-sell the products to veterinarians who, in turn, typically sell ZTS’s products to pet owners.
ZTS’s 2 largest customers are both distributors and they represented ~14% and ~7%, respectively of FY2017 revenue. No other customer represented more than 6% of revenue during the same period.
ZTS has demonstrated strong performance in the 5 years subsequent to its 2013 Initial Public Offering (IPO) as evidenced in the following images from the 2018 Annual Meeting of Shareholders Presentation on May 15, 2018.
Source: ZTS - 2018 Annual Meeting of Shareholders Presentation
Q2 2018 Financial Results
On August 2nd, ZTS released its Q2 2018 results and updated its guidance for FY2018. Details can be found here.
Source: ZTS - Q2 2018 Earnings Presentation - August 2, 2018
The all important free cash flow (FCF) metric continues to improve with ZTS having reported FCF under $0.5B in FY2013 – FY2016 and over $1.1B in FY2017.
Abaxis Acquisition
Prior to the release of its Q2 results, ZTS announced that it had closed the acquisition Abaxis, a leader in the development, manufacture and marketing of diagnostic instruments for veterinary point-of-care services for ~$2.0B; the intent to acquire Abaxis was announced May 16, 2018.
Abaxis, founded in 1989, is a leading provider of diagnostic instruments and consumable discs, kits and cartridges to the animal health industry. It reported revenue of $0.244B for its most recent fiscal year which ended March 31, 2018. This was an 8% increase from FY2017.
Source: ZTS to Acquire Abaxis Presentation – May 16, 2018
2018 Guidance
Full year guidance has been revised as follows:
- Revenue: $5.7B - $5.8B (previously $5.675B - $5.8B)
- Reported diluted EPS: $2.72 - $2.89 (previously $2.77 - $2.93)
- Adjusted diluted EPS: $3.00 - $3.10 (previously $2.96 - $3.10)
Credit Ratings
Moody’s initiated coverage in January 2013 at which time it rated ZTS’s senior unsecured debt Baa2 which is the middle tier of the ‘lower medium grade’ rating; this is 2 notches above non-investment grade.
In August 2017, Moody’s upgraded the debt to Baa1 and this is the current rating. This tier is upper tier within the lower medium grade category.
S&P Global rates ZTS’s senior unsecured long-term debt BBB which is the middle tier of the ‘lower medium grade’ rating; this is 2 notches above non-investment grade. This is one notch lower than Moody’s assigned rating.
Neither agency has ZTS’s credit ratings under review.
While there certainly is room for improvement, these ratings are satisfactory for my purposes. Neither rating agency is of the opinion ZTS will have any difficulty in servicing its obligations.
Valuation
ZTS’s stock price jumped $5.41 or 6.29% to close at $91.43 on August 2nd. On the basis of projected reported diluted EPS of $2.72 - $2.89, ZTS’s forward PE is ~31.6 - ~33.6. This forward PE range certainly does not suggest ZTS is a value at current levels. ZTS, however, has not been priced at a reasonable valuation level since becoming a publicly traded entity just a few years ago.
Annual revenue has increased from $2.76B in FY2009 to just over $5.3B in FY2017 which certainly is an impressive growth rate. Gross margin is also healthy at mid / upper 60s levels. While ZTS’s growth rate might warrant a slightly elevated valuation, I view ZTS as being currently priced to perfection.
Dividend, Dividend Yield and Dividend Payout Ratio
I was unable to locate ZTS’s brief dividend history on its website and had to find it here. That alone tells me that the dividend is not a top priority. Based on my analysis I am of the opinion management is focused on retaining profits for the purpose of growing the business.
While ZTS’s annual dividend has experienced double digit growth, we need to put this increase in perspective. In FY2017 the annual dividend was $0.42 and that for FY2018 is $0.504 (a 20% increase).
Based on the revised projected reported diluted EPS range of $2.72 - $2.89 for FY2018, the dividend payout ratio is below 20%. Investors should be pleased with this low payout ratio but given that the dividend yield is currently only ~0.55%, ZTS will likely have very little appeal to investor seeking a steady source of dividend income.
ZTS’s Performance vs S&P500
ZTS has only been a publicly traded company since 2013 so keep this in mind when looking at ZTS’s performance relative to the S&P500.
Source: TickerTech
Final Thoughts
ZTS is certainly an impressive company. An impressive company and a reasonable valuation, however, are separate and distinct. In my opinion, ZTS is somewhat expensive for my liking and I will pass on initiating a position at this stage.
Based on the earnings estimates of $2.72 - $2.89 for FY2018, ZTS would need to retrace to the lower $70s (PE in the low – mid 20s range) in order for me to seriously consider initiating a position.
I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected]
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I do not currently hold a position in ZTS and do not intend to initiate a position within the next 72 hours.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
