Initial Report: Zoetis (NYSE:ZTS), 35% 5-yr Potential Upside (EIP, Kenny CHENG)

Kenny presents a "BUY" recommendation based on positive outlooks as it continues to establish its presence in EMs and remains highly committed to its R&D efforts.

LinkedIn: Kenny Cheng

Executive Summary

Zoetis Inc. engages in the discovery, development, manufacture, and commercialization of animal health medicines, vaccines, and diagnostic products and services in the United States and internationally. The company commercializes products primarily across species, including livestock, such as cattle, swine, poultry, fish, and sheep and others; and companion animals comprising dogs, cats, and horses. It also offers parasiticides, vaccines, dermatology, other pharmaceutical, anti-infectives, animal health diagnostics, and medicated feed additives. In addition, the company provides animal health diagnostics, including point-of-care diagnostic products, instruments and reagents, rapid immunoassay tests, reference laboratory kits and services, and blood glucose monitors; and other non-pharmaceutical products, which include nutritionals, as well as products and services in biodevices, genetic tests, and precision animal health. It markets its products to veterinarians, livestock producers, and pet owners. The company has collaborated with Blacksmith Medicines, Inc. to discover and develop novel antibiotics for animal health. Zoetis Inc. was founded in 1952 and is headquartered in Parsippany, New Jersey.

Company Overview

Business Segment(s)

Zoetis organizes and manages its commercial operations across two segments: United States (U.S.) and International

Within these segments, the company delivers a diverse portfolio of products for companion animals and livestock, tailored to local trends and customer needs.

The company has recently gained approval for various product lines, which include Valcor™ (doramectin and levamisole injection), a prescription endectocide for the treatment and control of internal and external parasites in cattle, Protivity® , the first modified-live bacterial vaccine to offer protection against Mycoplasma bovis in healthy cattle and Bonqat® 3 (pregabalin oral solution) to treat the alleviation of acute anxiety and fear associated with transportation and veterinary visits in cats, helping them have a fear-free visit.

Revenue Driver(s)

US:

Growth in key franchises including Simparica Trio®, the company's flea, tick and heartworm combination product, the company's key dermatology portfolio, including Apoquel® and Cytopoint®, and the company's osteoarthritis (OA) pain products, Librela® for dogs and Solensia® for cats

International:

Growth in the quarter was driven by the company’s OA pain products, Librela for dogs and Solensia for cats, as well as its key dermatology products, Apoquel and Cytopoint. Also contributing to growth in the quarter was Simparica Trio.

Growth of both the company's cattle and poultry products were driven largely by price increases across the broader international segment.

Cost Driver(s)

1. Research and Development (R&D)

R&D is key to ZTS's business and within the competitive animal health sector, product innovation ensures that ZTS continues to lead the market with its wide variety of over 300 product lines.

As ZTS continues to commit to R&D efforts, it is expected that R&D expenses will continue to increase. A significant share of ZTS R&D investment is focused on product lifecycle innovation. R&D expenses increased from $508m (2021) to $539m (2022) and $614m (2023).

2. Selling, general and administrative expenses (SGA)

To increase net income, companies often look to cost reduction in the aspect of SGA.

Zoetis annual sg&a expenses for 2023 were $2.151B, a 7.07% increase from 2022.

Zoetis annual sg&a expenses for 2022 were $2.009B, a 0.4% increase from 2021.

Zoetis annual sg&a expenses for 2021 were $2.001B, a 15.93% increase from 2020.

SGA expenses have been increasing but margins have also been rising. This could mean that ZTS has efficient cost control measures or products which yield higher margins.

Competitor Analysis

Although ZTS is the largest player based on revenue in the animal health industry, there is stiff competition in the regions in which they compete in. Principal drivers of competition vary depending on region, species, product categories and development and more.

ZTS primary competitors include animal health medicines, vaccines and diagnostic companies such as Boehringer Ingelheim Animal Health Inc., Merck & Co., Elanco Animal Health and IDEXX Laboratories.

I believe ZTS would continue to lead the market for the following reasons:

1. ZTS holds the largest market share in the animal health industry and has strong brand recognition and reputation for the quality of products it provides. It leads the market with its comprehensive product offerings across various species and product categories.

2. ZTS has a diversified product portfolio which includes top-selling products like Simparico/ Simparico Trio and Apoquel/ Apoquel Chewable, contributed to approximately 13% and 10% of revenue respectively. This diversification provides stability, resilience against market volatility and ensures a steady revenue stream.

3. ZTS is committed to expanding its R&D capabilities and this is evidenced by the integration of AI into its Vetscan Imagyst platform and the acquisition of biopharmaceutical companies like PetMedix Ltd and adivo GmbH, positioning it well for future growth and market expansion.

Investment Theses

1. Growth for the animal health market

The global market size for animal medicine amounted to around 35 billion U.S. dollars in 2022. It was forecasted that the market would expand to some 60 billion dollars by 2032, equivalent to a compound annual growth rate (CADR) of 5.4 percent.

2. Climate change makes livestock susceptible to diseases

Among 65 animal diseases identified as most important to poor livestock keepers, 58% are climate sensitive. A rise in temperature, precipitation intensity, flooding and humidity can also increase pathogens’ or vectors’ metabolic processes, reproductive rates, resulting in enhanced vector–pathogen–host contact and, therefore, the risk of disease.

3. Pet ownership on the rise

More than two million people adopted a pet during the UK’s pandemic lockdowns, while in Australia over a million pets were adopted during the height of the pandemic.

Demographic changes, rising income levels and the Covid-19 pandemic have driven more people to adopt pets.

Pet ownership increased 113% between 2014 and 2019, and by 2024, experts estimate China will have the most pets in the world.25 Elsewhere in Asia, pet ownership in South Korea grew from 5 million to 7.5 million between 2014 and 2018, representing 50% growth

4. Increased approved products and claims for key product franchises

ZTS gained approval in Brazil for Valcor™ (doramectin and levamisole injection), a prescription endectocide for the treatment and control of internal and external parasites in cattle. Protivity® , the first modified-live bacterial vaccine to offer protection against Mycoplasma bovis in healthy cattle, was approved in the U.K. In the U.S., Bonqat® 3 (pregabalin oral solution) is now available to treat the alleviation of acute anxiety and fear associated with transportation and veterinary visits in cats, helping them have a fear-free visit.

Valuation

To get an estimate on the intrinsic value of ZTS share price, I conducted a comparable company analysis through looking at some notable competitors of ZTS. These competitors include Bayer, Merck & Co. and Pfizer.

To note, the P/E ratio of Merck & Co. is unusually high and that might skew some of the derived numbers. Hence, the intrinsic value of ZTS derived from the P/E ratios might be a less reliable estimate.

The range of intrinsic value of ZTS derived falls between $69.40 to $241.42.

ESG Assessment (Material Topics)

1. Product quality and safety

Zoetis closely monitors available global agency medical product safety and adverse event databases and reports adverse events as appropriate to global regulatory agencies in accordance with reporting requirements.

When their quality standards are not met due to deviations, out-of-specification and/or a failure of our manufacturing processes, ZTS conducts an investigation to determine the cause. Zoetis initiated five voluntary recalls in 2023. None of them were global recalls.

System (QMS) also ensures that their products are of the quality required for their intended use throughout the different stages of the product lifecycle. The QMS also extends to the control and review of outsourced activities and quality of purchased materials including quality risk management and oversight.

2. Selling practices and labelling

Across the globe, ZTS technical service veterinarians and field representatives support their customers by sharing knowledge on responsible use of ZTS antibiotic medicines, as well as educating customers on practices such as vaccination and other husbandry protocols that can help prevent common diseases. In the United States, ZTS finalized revisions to labelling for the reclassification of Zoetis’ remaining over-thecounter products to prescription only.

3. Diversity, equity and inclusion

DE&I strategy has four pillars that anchor and support ZTS efforts and balance both an internal and external focus:

Culture: ZTS is committed to maintaining an inclusive work environment where every colleague can thrive. DE&I is embedded in their purpose and core beliefs and is central to their employer value proposition.

Colleagues: ZTS is committed to a diverse global workforce, and they seek to ensure diversity and equity of opportunities for our colleagues are part of our internal and external pipeline management strategies.

Career: ZTS is committed to innovative talent and development processes that maximize the potential of their colleagues.

Community: ZTS is committed to advancing and supporting DE&I in our business practices, with our customers, and in the communities in which we live and work

4. Supply chain management

Zoetis conducts audits before doing business with suppliers and has well-developed periodic Supplier, Contract Service Provider and Contract Manufacturer Quality and Environment, Health & Safety audit programs.

ZTS aligns their procurement and supplier management processes to ambitious ethical, social and environmental-related principles. ZTS aims to work only with suppliers whose values are consistent with their own and support their suppliers in building their own sustainability capabilities. Throughout the life of their relationship with each supplier, ZTS seeks to ensure that their suppliers' conduct matches the expectations in the ZTS Supplier Conduct Principles and Supplier Conduct Position Statement.

Risk(s) and Mitigation Measure(s)

1. Heavy reliance on patents and intellectual property

Patents and intellectual properties are important elements of ZTS business. Its product portfolio enjoys the protection of approximately 5,880 granted patents and 1,490 pending patent applications filed in over 50 countries.

When patents expire, it gives rise to generic products which alter market dynamics and revenue streams. Patent expiration could have an adverse impact on ZTS share price.

To mitigate this, ZTS continues to innovate and invest in R&D to create new products. With a pipeline of new products, ZTS can capture market share and generate revenue once older patents expire.

2. Regulatory and manufacturing risks

The complex manufacturing processes and stringent regulatory environment in the animal health industry can lead to production delays or compliance issues.

To maintain compliance with these regulatory requirements, ZTS has established processes, systems and dedicated resources with end-to-end involvement from product concept to launch and maintenance in the market. ZTS's regulatory function also actively engages in dialogues with various global agencies regarding their policies that relate to animal health products.

ZTS regularly evaluates the adequacy of their manufacturing capabilities. The company purchased a manufacturing site outside Atlanta, Georgia in 2023, where ZTS plans to begin commercial production in the near future.

Additionally, the company recently signed an agreement to purchase a manufacturing site in Melbourne, Australia, that includes a currently leased site as well as additional space for expansion. The facility will be used to develop and manufacture vaccines for sheep, cattle, dogs, cats and horses and help ensure a long-term supply of products for Australia.

Conclusion

In conclusion, the outlook for ZTS seems to be positive as it continues to establish its presence in EMs and remain highly committed to its R&D efforts. This ensures that there is diversification and increased stability in ZTS revenue streams and that its product lines remain innovative to out compete with generic competitors. These would ensure that ZTS continues to snap up market shares in the animal health sector and dominate as the market leader.

*Do note that all of this is for information only and should not be taken as investment advice. If you should choose to invest in any of the stocks, you do so at your own risk.