Zoetis operates in the animal health sector, which is a resilient, essential, and expanding industry. Zoetis' track record of innovation has solidified its position as the industry leader consistently growing above the market. Zoetis has a clear strategy to grow its bottom line faster than its pipeline while returning significant capital to its shareholders. Thus, Zoetis sounds like a compelling investment, but at what price? It is what I will investigate in this analysis.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Zoetis. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I do not own any stocks in any of Zoetis' direct competitors either. Thus, I have no personal stake in Zoetis. If you want to purchase shares or fractional shares of Zoetis, you can do so through eToro.eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
The Business
Zoetis was founded in 1952 in New Jersey, United States. Zoetis was a subsidiary of Pfizer until it was spun off in 2013. Zoetis Inc. is a global leader in the animal health industry, focusing on the discovery, development, manufacturing, and commercialization of medicines, vaccines, diagnostic products, and services. Zoetis commercializes products across eight core species: dogs, cats, and horses (collectively referred to as companion animals) and cattle, swine, poultry, fish, and sheep (collectively referred to as livestock). The products fall within seven major categories: parasiticides, vaccines, dermatology, other pharmaceuticals, anti-infectives, animal health diagnostics, and medicated feed additives. Zoetis has two operating segments: the United States, which contributed 53% of the revenue in 2023, and International, which contributed 47% of the revenue in 2023. Zoetis' products for companion animals usually have higher profit margins than those for livestock. Zoetis generates approximately 77% of its revenue from companion animals in the United States and 52% from companion animals internationally. Zoetis primarily sells its companion animal products to veterinarians or third-party veterinary distributors, who typically then sell the products to veterinarians. In each case, veterinarians then sell the products to pet owners. Zoetis sells its livestock products primarily to veterinarians and livestock producers. Zoetis' brands, trusted by both pet owners and veterinarians, and its patents are what give Zoetis its moat.
Management
The CEO is Kristin Peck. She helped usher Zoetis through its Initial Public Offering in 2013 and has been a driving force of change in many roles at the company. She became CEO in 2020. Before joining Zoetis, Kristin Peck served as the Executive Vice President of Worldwide Business Development and Innovation at Pfizer Inc., and was a member of Pfizer's Executive Leadership Team. In that role, she was responsible for evaluating strategic alternatives for Pfizer's Animal Health and Nutrition businesses. Prior to joining Pfizer, Kristin Peck held roles at The Boston Consulting Group. Kristin Peck serves on the boards of BlackRock, Mayo Clinic, and Columbia Business School, and is a member of the Business Roundtable. She holds a bachelor's degree from Georgetown University and an MBA from Columbia Business School. Kristin Peck has been recognized for her leadership and Zoetis' strong performance during challenging times. She was named by Barron's as one of the top CEOs in 2022 and by Fortune as a 2020 Businessperson of the Year. According to Comparably, Kristin Peck has an employee rating of 84/100, which puts her in the top 5% of similar-sized companies. I believe that her strong execution, experience in the sector, and high employee rating show that she is a great CEO. I am comfortable with Kristin Peck leading Zoetis moving forward.
The Numbers
The first metric we will investigate is the return on invested capital (ROIC). I would like a 10-year history demonstrating a minimum annual growth of 10%. The numbers are promising, as there has only been one year in the past ten years where Zoetis has not managed to deliver a Return on Invested Capital (ROIC) above 10%, and that was many years ago. Zoetis has managed to deliver a Return on Invested Capital (ROIC) above 15% since 2018, which is impressive. What is even more impressive is that Zoetis has delivered its highest Return on Invested Capital (ROIC) in the past three years, increasing every year. Hence, Zoetis managed to achieve a Return on Invested Capital (ROIC) above 20% for the first time ever in 2023. Hopefully, this trend will continue, and Zoetis will manage to deliver a ROIC above 20% moving forward.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most significant of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. The numbers are positive as Zoetis has only experienced a decline in one year. It is encouraging that Zoetis has increased its equity almost every year since its IPO and that it achieved its highest equity ever in 2023.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising to note that Zoetis has consistently generated positive free cash flow every year for the past ten years. Free cash flow grew almost every year until 2022, which was a challenging year for many companies due to factors such as high inflation, impacting the free cash flow of Zoetis. However, Zoetis seems to be back on track in 2023, as free cash flow grew once again, even though it did not reach the peak in 2021. Nonetheless, I expect free cash flow to continue growing. Levered free cash flow margin has been lower in the past two years compared to the five years prior, primarily due to macroeconomic factors. Free cash flow yield is around the ten-year average but higher than in the three years prior, which indicates that Zoetis is trading at a better valuation than before, even though the 2,1% free cash flow yield doesn't suggest that the stock is inexpensive. However, we will revisit that later in the analysis.
Debt
Another important aspect to consider is the level of debt. It is crucial to determine if a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. After analyzing Zoetis' financials, I found that the company has 2,8 years' worth of earnings in debt. It is less than three years, which means that debt is not a concern for me when investing in Zoetis. It is also worth noting that this is the lowest earnings-to-debt ratio that Zoetis has had since its IPO.
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Risks
Based on my findings so far, I find Zoetis to be an intriguing company. However, no investment is without risk, and Zoetis also has its fair share of risks. One of the risks is competition. In its annual report, Zoetis mentions that the animal health industry is highly competitive. Zoetis believes that many of its competitors are conducting research and development activities in the same areas where Zoetis currently offers products and in areas where Zoetis is working on developing new products. The competitors include standalone animal health businesses, start-up companies working in the animal health sector, and the animal health divisions of large pharmaceutical companies. Furthermore, Zoetis believes that in recent years, there has been an increase in consolidation in the animal health industry. This trend could lead to existing competitors realizing additional efficiencies or improving portfolio bundling opportunities. Consequently, this may potentially increase their market share and pricing power, which could, in turn, lead to a decrease in Zoetis' revenue and profitability and an increase in competition.
Its China business. During an earnings call, Zoetis mentioned that although China accounts for less than 5% of Zoetis' global revenues, the persistent economic weakness in the region continues to affect Zoetis' business. This situation resulted in a half-percentage-point decline in the company's total operational revenue growth for the year. Management has mentioned that they are not assuming a change in the current economic situation in China. This implies that they expect a headwind to growth in 2024, as they continue to see low consumer confidence and persistently depressed swine prices affecting consumption in the region.
A strong dollar. Zoetis makes 47% of its revenue outside the United States. Therefore, a strong dollar can impact Zoetis' results. In 2023, foreign exchange rates negatively affected Zoetis' margins by 80 basis points. Management expects that foreign exchange rates will continue to have a negative impact on Zoetis in 2024, as they anticipate an unfavorable effect on Zoetis' growth compared to 2023. One example is that management expects foreign exchange to negatively impact their net revenue growth by 90 basis points.
Reasons to invest
There are also numerous reasons to invest in Zoetis. One reason is that the management has mentioned that the powerful human-animal bond is a growing global trend. It means that pet owners today are more focused on animal health than ever before. Pet owners are now younger and wealthier than historically, while pets live longer. It means that the animal health sector is expected to grow from $45 billion today to $80 billion in 2032. Zoetis believes that it has products that will benefit from this trend. Zoetis has just launched Librela, which is the first and only monthly injectable anti-nerve growth factor monoclonal antibody therapy for dogs with osteoarthritis pain. Management believes that its pain franchise could generate peak sales exceeding $1 billion. Furthermore, increasing pet owners' awareness that itch is a medical condition requiring treatment means that Zoetis can continue to expand its dermatology franchise in the US and internationally.
Another global trend that management has mentioned as a growth driver is the world's increasing demand for a sustainable supply of animal protein. The global population is growing at a fast pace, and it is expected that there will be nearly 2 billion more mouths to feed by 2050. This trend is leading to an increasing demand for animal protein sources. Furthermore, meat consumption is growing faster than the population growth as GDP growth in developed countries increases the demand for meat. Zoetis will benefit from this trend because of its diverse portfolio across markets and therapeutic areas that serve a wide range of species. Another trend that will benefit Zoetis is the increasing importance of global food security. Producers are now responsible for ensuring a high-quality, safe, and reliable food supply, which should have a positive impact on Zoetis.
Zoetis is shareholder-friendly. One of Zoetis' four principles is to return excess capital to shareholders. Zoetis aims to achieve this through share buybacks and dividends. Zoetis returned approximately $1,8 billion to shareholders in 2023 through a combination of share buybacks and dividends. In December 2023, Zoetis announced a 15% annual dividend increase, continuing its commitment to grow its dividend at a rate equal to or faster than the growth in adjusted net income.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 5,07, which is from the year 2023. I have selected a projected future EPS growth rate of 11,5%. Finbox expects EPS to grow by 11,5% in the next five years. Additionally, I have selected a projected future P/E ratio of 23, which is double the growth rate. This decision is based on Zoetis' historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $85,61. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Zoetis at a price of $42,81 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 2.353, and capital expenditures were 732. I attempted to analyze their annual report in order to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 512 in our calculations. The tax provision was 596. We have 458,367 outstanding shares. Hence, the calculation will be as follows: (2.353 – 512 + 596) / 458,367 x 10 = $53,17 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Zoetis' free cash flow per share at $3,53 and a growth rate of 11,5%, if you want to recoup your investment in 8 years, the Payback Time price is $47,54.
Conclusion
I find Zoetis to be an interesting company with good management. It is also encouraging that the company is increasing its Return on Invested Capital (ROIC), which reached 20% for the first time in 2023. Zoetis is facing some short-term challenges. One issue is the strong dollar, which has negatively impacted margins due to foreign exchange rates. But while management expects these challenges to continue in 2024, I still believe that these challenges will be short-term. The Chinese market isn't growing as expected, which has had a negative effect on Zoetis. Zoetis expects these challenges to continue in 2024 but has mentioned that they believe China to be a strong market for them long-term, indicating that the challenges in China appear to be short-term. Competition is a long-term risk that Zoetis needs to address, as they have historically. It will be interesting to see if the consolidation in the animal health market will lead to increased competition, which is something that needs to be monitored. There are two major global trends that benefit Zoetis. The demand for animal protein is expected to drive Zoetis sales, and with populations and GDP projected to continue growing, I anticipate this trend to persist for decades. The powerful bond between humans and animals continues to strengthen, which will also benefit Zoetis. Research has shown that when faced with a 20% decrease in budget, pet owners will not spend less on their pets. Therefore, Zoetis' business is also resilient. Finally, Zoetis continues to benefit investors through dividends and buybacks, and this trend is expected to persist, a factor that investors appreciate. I would love to add Zoetis to the portfolio if it reaches $106, which is the intrinsic value based on the Ten Cap price.
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