Questionable Timing

Zoetis' Q4

Zoetis reported Q4 earnings last week and set its 2026 outlook. Even though the earnings were not bad per se, I must say that I am a bit disappointed with the performance of the business. Before discussing what disappointed and worried me, let’s take a look at the numbers.

2025 numbers were not bad in and of themselves. Zoetis delivered 6% growth in revenue and 7% growth in adjusted net income (excluding the sale of the MFA business) in 2025, but the development of the business throughout the year was not ideal. This is how organic operational revenue growth evolved throughout the year:

• Q1: +9%

• Q2: +8%

• Q3: +4%

• Q4: +4%

Management blamed the deceleration on several things. First came the Librela weakness which shifted from a tailwind to a headwind throughout the year. Then, the company faced (surprising) macro pressures that weighed on therapeutic visits. These continued in Q4:

In the veterinary channel, we continue to see some economic pressure on Gen Z and millennial pet owners, which has contributed to a decline in therapeutic visits.

Last quarter I explained why I viewed this “excuse” as surprising. Management had been telling investors for years that Zoetis was not as exposed to vet visits as the industry at large, only to later blame these for subpar performance. This coincided with a period of heightened competition, which evidently worried investors (i.e., were vet visits really the issue?)

Thirdly, management blamed an “unsustainable” competitive landscape:

We are also operating in a more competitive landscape, including elevated promotional launch activity, which historically has not been sustainable.

Management believes these three headwinds are temporary, which brings us to the outlook. Despite the temporary nature of the above headwinds, the outlook came in below what I would expect from a business like Zoetis (albeit it does need context). Management guided to organic operational revenue growth between 3% and 5% and adjusted net income growth of 3% to 6%. Assuming recent repurchases, organic EPS growth should be ahead of adjusted net income growth. Management argued that the recent repurchases funded by the convertible bond offering will provide a 22 cent tailwind to EPS. Zoetis achieved EPS of $6.02 in 2025, meaning that this results in a 3.6% tailwind. We could somewhat infer that EPS will grow (organically) closer to HSD in 2026 (assuming the guide is met).

This is not a bad result all things considered, but if looked in isolation it seems quite disappointing. Zoetis currently trades at an EV/EBIT of 17x. While this doesn’t seem necessarily expensive for a business of Zoetis’ quality and the tailwinds it’s exposed to, I must say it becomes more expensive when considering the opportunity set (i.e., what’s currently available in the market at decent valuations). Just for context, Medpace is currently trading at around a 20x EV/EBIT despite growing roughly three times faster than Zoetis and despite its management team being of a higher quality. I don’t like to make these comparisons because these businesses are evidently not comparable and there’s much more to a valuation than a growth rate, but you know what I mean.

Now, this doesn’t mean that holding Zoetis is not consistent with holding other companies that might look cheaper. At the end of the day, we can be wrong and diversifying (at least to an extent) makes sense. This, however, should have implications for weight allocations (in my opinion).

Now, all this said, I do believe the 2026 guide is likely conservative and probably not representative of Zoetis’ long-term growth profile, for several reasons. First, management already screwed up in Q3 after being too optimistic in Q2. That has probably tempered their optimism when providing the annual guide (or at least, it should’ve). Secondly, management outright told investors that they are being conservative:

We always take into consideration various factors in terms of within the range of guidance that we give, which we believe is certainly prudent in terms of how we positioned it.

What’s interesting is that, in its Q3 earnings call, management claimed that the new guide they were issuing for Q4 was not necessarily representative of what was to come in 2026. This somewhat calmed the market (albeit not much), but the market was right on this one: the 2026 guide is somewhat in-line with what Zoetis guided for in Q4 2025 (and maybe even worse). This leaves two options on the table:

1. Management lied in Q3 and/or the environment deteriorated more

2. Management is being conservative with its 2026 guide

If we look back at history we can see that there’s no clear trend in management’s conservativeness. Since 2021, this is how Zoetis has fared against its initial revenue growth targets:

• 2021: guided for 9-11%, achieved 15% (significant beat)

• 2022: guided for 9-11%, achieved 8% (missed)

• 2023: guided for 6-8%, achieved 7% (met)

• 2024: guided for 7-9%, achieved 12% (significant beat)

• 2025: guided for 6-8%, achieved 6% (met)

Now, these numbers need context. For example, the 2021 beat was achieved thanks to the post-pandemic boom in pet ownership. There are reasons to believe that those puppies that entered the market in 2021 are now getting to an age where their medical needs increase (i.e., Zoetis and the industry suffered an “air pocket” as puppies grew up). The outlier in that air pocket was 2024, the year when Zoetis launched Librela in the US. This also brings up an interesting topic: Zoetis growth might be more cyclical and subject to product releases than I previously anticipated.

Zoetis held an innovation day a while ago in which they discussed all the blockbusters that they expect to launch in the future. One might ask themselves: aren’t these blockbusters contributing to 2026 growth? The answer is that…not much. Lenivia and Portela (the new OA pain mabs) have been both approved in the EU and Canada, but management doesn’t expect an approval in the US at least until 2027 (and this is the market that really matters, without disregarding the rest). To this, we must add that Zoetis is not considering in the guide revenue from any other treatment that has not yet been approved. This means that there’s potential upside to the guide, but that 2026 is most likely to be an air pocket before innovation starts contributing to the numbers:

We’re very excited about the pipeline, and yes, some of the bigger areas that we have in our pipeline will start to contribute as we look out into the 2027, 2028 time frame.

One thing that worries me about the guide (and Zoetis’ recent growth) is how the growth algorithm has shifted. Take a look at how organic growth has evolved between price and volume over the past few years:

• 2021: 1% price, 14% volume

• 2022: 3% price, 6% volume

• 2023: 5% price, 2% volume

• 2024: 6% price, 5% volume

• 2025: 4% price, 2% volume

Notice a trend? Even though “price” doesn’t mean outright price increases (there might be price mix in it too, like the conversion from Apoquel to Apoquel Chewable), I believe there’s food for the bulls and the bears here. For the bulls: Zoetis can achieve good growth even during periods of low volume growth caused by few product releases. This growth shoots up as soon as Zoetis delivers a blockbuster (2024 a good example with Librela).

For the bears: Zoetis growth algorithm is now much more skewed towards price, which is less sustainable. I am of the opinion that growth here is going to be lumpy but Zoetis should be fine so long as it continues to bring innovations to market first (although this is worth monitoring). The guide for 2026 also reflects these dynamics: management is assuming 2-3% of price in the guide, which means that Zoetis can potentially just grow with price in 2026.

Now, with all this said, competition is a topic that’s increasingly being discussed at Zoetis’ calls, more so as there are rumours that Merck might spin out its animal health segment. Management mentioned that they had seen “minimal impact from recent competitive launches internationally.” Now, the company is facing mounting pressure in the US from competitive launches, but I believe that what they are trying to prove by saying this is that, despite these competitors being present internationally for longer, Zoetis’ products continue to gain share. This, in my view, is their way of saying that they expect the noise around the competitive launches in the US to be temporary. This is still TBD, but it’s an important part of the thesis. The pressure in the US can be seen specifically in companion (note that Librela’s -32% YoY growth also contributed significantly to this performance):

US revenue was flat in the quarter, with companion animal declining 1%.

During the last earnings call management claimed that they expected the OA pain headwinds to moderate and for Librela to turn to growth in 2026…but their messaging is now a bit unclear:

While we do expect these headwinds to continue into 2026, the impact on our growth should moderate as we move through the year.

Despite all the competitive headwinds (mainly in derm) management does expect growth across its key franchise in 2026 (which is good).

Not the best moment for accounting changes

Zoetis’ management took pretty much everyone by surprise when they said the following:

To support our strategy and drive greater speed, productivity, and insight, we’re advancing our multi-year, multi-phase initiative to transition our ERP system. This initiative leverages our existing strengths, further modernizing the way we operate day to day and enhancing our ability to capture and report insights on our global business. As part of this effort, we are expecting to eliminate the one-month reporting lag of our subsidiaries operating outside the United States, aligning our fiscal year with calendar year 2026 on a global basis. When we adopt the expected fiscal year alignment, we will retroactively apply the new accounting principle to prior financial statement periods, enabling a clear comparison of our financial results to historical operations.

Now, this accounting change is pretty much immaterial and is mostly timing, but I must say that I don’t particularly like seeing these accounting changes when things are not going well, more so when they are a tailwind the numbers (even if minor):

Look, in terms of the 3%-5% operational growth, that is our expectations for 2026 on the same basis that we have always reported, and certainly that factors the baseline, which is 2025, and the performance throughout the year, inclusive of the fourth quarter. Now, put into context here, the amount we’re talking about for 2025 is effectively 30 basis points-40 basis points of the total company for 2025. This is not a significant amount that would swing the range of growth that we’re expecting for 2026 in any material way, is what I would say. And again, we’ll provide on a like-for-like basis, recasted financials when we implement the fiscal year alignment, and hopefully that will be very clear for everyone.

Like I said, it’s probably nothing, but timing is somewhat suspicious. Some operational changes that were made to align with these accounting changes benefited Q4 numbers:

Our international revenue in the fourth quarter was positively impacted by certain operational changes made in connection with our expected fiscal year alignment for our subsidiaries outside the United States. These operational changes resulted in the acceleration of the timing of sales into the reported fourth quarter of 2025, leading to an approximate 2.5%-3.5% increase in sales in the international segment in the quarter.

This pull forward had more implications than many believe. Zoetis beat the market’s revenue estimate by $25 million. A 2.5% to 3.5% increase in Q4 international sales amounted to around $28 million, so Zoetis’ beat in Q4 could somewhat be attributed to these operational changes. I don’t think this is material whatsoever, but it’s worth noting that the accounting changes come at a time when Zoetis is not doing particularly well and they (coincidentally) benefitted the company’s numbers.

So, all in all, an okay quarter, but one can’t be too excited about these numbers.

Have a great day,

Leandro