Zoetis’ Q3: “Invest in the world we live in, not the world we want.”
Hi reader,
I have had a pretty intense earnings season, and I have not had time to publish all earnings digests in the manner I would’ve liked to (timing-wise). As I acknowledge that these articles tend to be quite time-sensitive and a bit of time has gone by since both Intuit and Zoetis reported earnings, I thought it would be a better idea to bring a short article with some brief comments. The good news (and a spoiler) is that not much has changed in the thesis of any of these companies, and, if anything, they continue to perform better than the market expects. Whenever something material in any thesis has changed, you can count on me publishing that article relatively fast.
This article will be about Zoetis, and I plan to bring Intuit’s earnings digest early next week (it’s a bank holiday here in Spain).
Zoetis’ earnings
Zoetis reported a great quarter a month ago despite its shares not enjoying a good market reaction. Shares were down after earnings, but have recovered since and are pretty much at the same level today:
The post-earnings share drop was “puzzling” (to say the least) because Zoetis reported a flawless quarter while not being priced for perfection (this last part is important).
The company beat both revenue and earnings estimates and raised guidance. Just a stat here: Zoetis has delivered three consecutive beat-beat-raise quarters this year:
The main highlight was the company’s accelerating growth. Zoetis posted an 11% quarterly growth rate (14% operational growth), the highest since the pandemic period when the company saw its revenue surge. Growth has been accelerating steadily for some quarters now. I recall some people saying in 2022 that Zoetis was a no-growth business (true story!):
There are several sources behind this accelerating growth. The main one is the company’s OA pain MABs (monoclonal antibodies). Librela and Solensia continued doing very well in the US and abroad, and the franchise grew a whopping 97% operationally year over year.
Despite these strong growth rates and the franchise’s significant scale (“Librela has already become the 4th largest product in the US.”) the runway is still significant. In Europe, the franchise is still growing significantly (+27% operational growth) despite its scale because it’s already treating milder cases. Treating milder cases brings two potential benefits:
The patient population increases
The patient population stays longer in the product, reducing churn
Wetteny Joseph, the company’s CFO, shared the following stat during a recent investor conference:
So in a given year, how many months are the patients on the product? And that’s gone from 2 or so, two and half years ago, 4 to 5 months, and then went for 6 or 7 months, now it’s 7 to 8 months.
The OA MABs franchise also demonstrates how Zoetis creates markets, a key aspect behind the investment thesis. It’s not that Zoetis’ TAM is pretty large and growing; it’s also that there are markets that currently generate $0 in revenue that might be generating hundreds of millions in the future. Librela and Solensia were not part of Zoetis’ TAM many years ago, but they are now on pace to become a +$1 billion franchise.
In the US, Librela has brought almost 500k new patients to the OA pain category.
All this said, if there’s one thing we can expect from the market is that it will always find something to worry about! This time it was Librela’s sequential growth in the US (the product did not grow sequentially). Management argued that growth is not linear in newly created categories, which is the reason why they don’t focus on the sequential growth rates. While this might be simply something they say to cover potential problems, it’s ironic that precisely the same thing happened in Europe with Librela a year ago:
If you look at last year, this time in Q3, the question on the earnings call was why did we not see sequential growth in Librela in Europe. A year later, it’s why we’re not seeing sequential growth in Librela in the US.
Needless to say, Librela continued doing pretty well in Europe despite this bump.
Strength did not just come from OA pain MABs. Other key products/franchises like Simparica (+27% operational growth) and dermatology (+16% operational growth) continued to do well and (you guessed it) continued to face questions regarding competition. Simparica Trio has grown revenue substantially this year despite already facing competition, and Zoetis expects something similar will happen with Apoquel (which expects to suffer competition early next year).
Management claims that competition helps grow the market but that it’s unlikely to make a significant dent in its franchises in the absence of a truly differentiated product. This has been the case in the past, and I don’t see any reason why it should change in the future. Parasiticides is a pretty competitive category, and Zoetis continues to grow and gain market share:
Parasiticides is the largest, most competitive therapeutic category in animal health, and we have substantially increased our market share by being the first to market in the US. In the first year of competition in US Triple combinations, we grew revenue by more than 25% and increased our market share.
Management went on…
Secondary entrants serve to accelerate conversion from older therapies, but in the absence of meaningful differentiation, they do not erode market share.
Once you build it, it’s also very sticky because you’ve established the standard and someone else has to come up with something that is significantly differentiated in order to overtake you.
Apoquel’s case is interesting because the new competitor is coming out with a pill, not a chewable. Zoetis has already converted 30% of its Apoquel patients to Apoque Chewable and believes the competitor should help them bring untreated animals into the franchise but should not erode its market share as products will not be comparable.
Another thing the market seems worried about is price increases. Veterinary inflation has been ahead of CPI inflation for some time, and many wonder how much longer that can last until an affordability crisis breaks loose. There’s no denying that Zoetis is increasing prices above historical norms, but this quarter’s growth was pretty balanced across volume (+8%) and price (+6%). Note here that price refers not only to outright price increases but also to the product mix. As more innovative products (like Apoquel Chewable, the OA pain MABs…) come into the mix, it’s normal to see prices go up.
More good news came from the guidance side, but it needs context. Zoetis revised its estimated operational growth in revenue from 10% to 10.5% but revised its operational growth in net income downward from 14.5% to 14%. The company still expects margin expansion this year, but to a lesser extent:
Several things worth pointing out here. The first one is that Zoetis completed the sale of its feed additive portfolio to Phibro Animal health October 31st. This was a $100 million/quarter business, so the company will basically see 2/3rd of this amount “evaporate” next quarter ($66 million). This is something that will be probably ignored in the operational growth number but that will most likely impact the reported Q4 numbers.
The impact of this sale will probably be most noticeable next year, but I think it’s good news to see Zoetis become a more focused company. Throughout many of my articles I have repeated that companies should strive to get better, not bigger, and Zoetis seems to be doing just this. Of course, selling this business is not the end of the story: seeing what management does with the proceeds is also key, but that’s something we’ll only be able to judge in hindsight.
Management also highlighted their confidence for strong growth in 2025, a year that will be marked by the continued rollout of its OA pain MABs and the arrival of competition for one of its flagship products: Apoquel. If history is any guide we should not see Apoquel suffer too much despite the arrival of competition, but it will be interesting to follow.
All in all, Zoetis reported a very good quarter, achieving a beat-beat-raise for the third consecutive quarter and with strength being broadbased. Animal health remains a growth industry as pets become family members, and based on the news flows, I expect this to continue. Just to give you some stats…
In Spain there are more dogs (9.3 million) than children under the age of 14 (6.6 million)
In the US there are around 90 million dogs and 72 million children under the age of 17
The population of dogs/pets is pretty large, and the best thing for Zoetis is that a good deal of these pets remain under or completely untreated for two main reasons:
They suffer from an unmet need
Owners don’t know that there’s a treatment for that condition or don’t know their pet has the condition in the first place
The fact that there is an increasing number of pets and a decreasing number of children is good news for Zoetis, but maybe not so much for society. As Charlie Munger (?) used to say…
We have to invest in the world we live in, and not the world we want.
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In the meantime, keep growing!