by James Brumley | August 12, 2013 8:57 am
Zoetis (ZTS) isn’t a household name. In fact, there’s a very good chance you — like many investors — have even heard of it. After all, it’s not like a $15 billion animal pharmaceutical company commands the kind of serious media attention that a manufacturer of some hot consumer technology product can garner.
As I’ve pointed out a handful of times lately, though, it’s the obscure and unlikely stocks that tend to dole out the biggest rewards, and Zoetis ranks plenty high on the obscure scale. So should you buy Zoetis with the hopes that it’s the market’s next unknown and unexpected name to score big gains for its shareholders?
If you have a pet or own a farm, odds are good you’ve actually used a Zoetis-made product. The company supplies a few dozen common drugs and tests used by veterinarians. In fact, ZTS sold $4.3 billion worth of animal medications and diagnostic equipment last year, turning a $436 million profit in the process.
That’s not why the name Zoetis (pronounced zō-EH-tis) may ring a bell with you, though. Zoetis is the company Pfizer (PFE) spun off in January of this year in an effort to let each company flourish or flounder on its own.
So far, Zoetis has found itself right in the middle of the flounder/flourish scale; ZTS shares are currently trading right around the price they were issued at in late January. The company also simply met estimates last quarter too, earning the expected 36 cents per share. Revenue was up a couple of percentage points, but just missed sales estimates. Operating earnings were up a measly penny per share.
All in all, recent results have been mediocre, as the stock’s year-to-date performance reflects.
You don’t own companies for their past performance, though. You own them (or not) based on their future potential. Is there any chance Zoetis could turn up the heat and really become something worth taking a shot on? That depends.
Product Line: If nothing else, ZTS shareholders can rest easy in the knowledge that the company has a wide and well-adopted library of products used by the veterinary industry. Even if Zoetis doesn’t add one more revenue-bearing product to the mix for years, it could do well for years with just the ones currently on its menu. That being said …
China: … Zoetis is at the very least expanding its reach. Just a few days ago, the company announced that its joint venture got Chinese approval for the Rui Lan An vaccine (for a particular swine respiratory infection). Not only is China a significant market opportunity (about $5 billion is spent on medicines for livestock in China every year), but the approval of the drug gives Zoetis a strong foothold in the market.
Third Parties: Whether Zoetis decides to add to its own drug portfolio might not necessarily matter as much as one might think, as the company will be opening up its laboratory doors to third parties needing a place to make their own animal medicines. The Nebraska plant’s manufacturing capacity is nowhere near fully tapped, so the company is inviting others to set up shop there … for a fee, of course. The “rent” might not be ultra-profitable, but it beefs up the reliability of cash flow. Give the plant a couple of years to reach full capacity.
Valuation: Priced at 34 times their trailing earnings, it’s not like ZTS shares could be considered a bargain. The forward-looking P/E of 19.5 is a little more palatable, but already seems to factor in the approval of the Rui Lan An swine vaccine in China. Point being, it’ll be tough to justify even stronger premium pricing than we’re seeing for the stock now unless the company gets huge traction with new medicines in China very soon.
Little Protection: Dividend fans have nothing to look forward to here, with a dividend yield of only 0.8% and no real prospect of a big dividend hike in the foreseeable future. Net margins of just under 11% are reliable, and solid, but not wide enough that the company will up its payout because it can’t find anything else to do with that cash.
Competition: While Zoetis is certainly capable of standing on its own indefinitely, its competitors don’t have to. Animal healthcare name Elanco still has the support and assistance from its parent company Eli Lilly (LLY), and the animal medicines division of Merck (MRK) remains under muscular, well-funded wings. If the need or opportunity arose, that backing means Zoetis’ rivals could make some serious trouble for the company.
To be fair, you could do much worse than Zoetis. It’s stable and reliable. The trouble is, you could do a lot better. Its growth prospects are decent, but it’s going to be slow growth.
So should you buy Zoetis? No — higher-octane opportunities are out there, and at a much lower price.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
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