Zoetis - Credit Suisse
Transcript of Zoetis - Credit Suisse
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CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION®
Client-Driven Solutions, Insights, and Access
3 February 2016 Americas/United States
Equity Research Animal Health
Zoetis (ZTS) Rating OUTPERFORM Price (02-Feb-16,US$) 41.72 Target price (US$) 58.00 52-week price range 55.38 - 39.65 Market cap (US$ m) 20,773.24 Enterprise value (US$ m) 23,807.24 *Stock ratings are relative to the coverage universe in each
analyst's or each team's respective sector.
¹Target price is for 12 months.
Research Analysts
Erin Wilson
212 538 4080
INITIATION
Leader of the Pack: Top Pick in Animal Health We Are Initiating Coverage of Zoetis with an Outperform Rating and
$58 TP: As the global leader in therapeutics for livestock and companion animals, ZTS is highly levered to rebounding industry fundamentals, and earnings growth should accelerate over an improving cost and capital structure. Our focus is on underappreciated efficiency initiatives that should drive over 900 bps operating margin expansion by 2017, a considerable feat for a company of its size that ensures double-digit EPS growth in 2017 and beyond.
Constructive on Fundamentals, Cost Structure: While restructuring will curtail NT growth, rebounding demand, as supported by proprietary survey work, should drive consistent revenue growth of 5-7%. New products and services, a business mix increasingly skewed toward faster-growing geographies and species, and efforts to optimize operations as an independent company should fuel revenue growth ahead of the industry and build EPS momentum. Execution on these initiatives is ahead of plan in 2016, offering potential profit upside, a possible near-term catalyst. With strong free cash flow ($1B in 2016E), its capital deployment efforts prioritize value-added M&A, which we view as poorly understood, as well as share buybacks, deleveraging, and an ongoing commitment to dividend hikes.
Valuation Compelling—An Attractive Alternative HC Investment: With its shares down 25% (-10% S&P 500) from a high in June, they currently trade at 16.7x our 2017 EPS, well below its peer group (25.2x). Our $58 TP is based on a P/E multiple of 23.0x, which better reflects its accelerating growth prospects, operational and capital deployment opportunities, and its competitive positioning as a diversified, established leader in animal health for which there are inherent advantages. We view ZTS as an attractive alternative health care investment, sheltered from onerous reimbursement and regulatory challenges, R&D inefficiencies, and other issues overhanging human health care. Risks to our call include weather, FX, epidemiological, or macro headwinds as well as activist involvement.
Share price performance
On 02-Feb-2016 the S&P 500 INDEX closed at 1903.03
Daily Feb03, 2015 - Feb02, 2016, 02/03/15 = US$43.5
Quarterly EPS Q1 Q2 Q3 Q4 2014A 0.38 0.38 0.41 0.40 2015E 0.41 0.43 0.50 0.39 2016E 0.42 0.45 0.50 0.41
Financial and valuation metrics
Year 12/14A 12/15E 12/16E 12/17E EPS (CS adj.) (US$) 1.57 1.74 1.78 2.28 Prev. EPS (US$) P/E (x) 26.6 24.0 23.4 18.3 P/E rel. (%) 163.7 147.6 152.9 135.1 Revenue (US$ m) 4,785.0 4,727.5 4,817.3 5,114.2 EBITDA (US$ m) 1,329.0 1,484.5 1,603.6 1,892.7 OCFPS (US$) 2.65 2.96 3.21 3.81 P/OCF (x) 16.3 14.1 13.0 10.9 EV/EBITDA (current) 17.9 16.0 14.6 11.9 Net debt (US$ m) 3,054 3,034 2,602 1,706 ROIC (%) 20.89 22.22 25.57 41.63
Number of shares (m) 497.92 IC (current, US$ m) 4,153.00 Net debt (Next Qtr., US$ m) - EV/IC (x) - Net debt/tot eq (Next Qtr.,%) - Dividend (current, US$) - Source: Company data, Thomson Reuters, Credit Suisse estimates
3 February 2016
Zoetis (ZTS) 2
Zoetis (ZTS)
Price (02 Feb 2016): US$41.72; Rating: OUTPERFORM; Target Price: US$58
Income Statement 12/14A 12/15E 12/16E 12/17E
Revenue (US$ m) 4,785.0 4,727.5 4,817.3 5,114.2 EBITDA 1,329 1,484 1,604 1,893 Depr. & amort. (143) (170) (132) (132) EBIT (US$) 1,186 1,314 1,472 1,761 Net interest exp (117) (114) (146) (146) Associates - - - - Other adj. 11 7 0 0 PBT (US$) 1,080 1,207 1,326 1,615 Income taxes (290) (332) (437) (484) Profit after tax 790 875 888 1,130 Minorities (4) (3) -0 -0 Preferred dividends - - - - Associates & other 0 0 0 0 Net profit (US$) 786 872 888 1,130 Other NPAT adjustments 0 0 0 0 Reported net income 786 872 888 1,130
Cash Flow 12/14A 12/15E 12/16E 12/17E
EBIT 1,186 1,314 1,472 1,761 Net interest (117) (114) (146) (146) Cash taxes paid - - - - Change in working capital - - - - Other cash & non-cash items 260 284 278 278 Cash flow from operations 1,329 1,484 1,604 1,893 CAPEX (292) (610) (125) (125) Free cashflow to the firm 1,037 874 1,479 1,768 Aquisitions - - - - Divestments - - - - Other investment/(outflows) 0 0 0 0 Cash flow from investments (292) (610) (125) (125) Net share issue(/repurchase) - - - - Dividends paid (146) (167) (184) (202) Issuance (retirement) of debt - - - - Other (898) (687) (862) (670) Cashflow from financing activities (1,044) (854) (1,046) (873) Effect of exchange rates - - - - Changes in Net Cash/Debt (7) 20 432 895 Net debt at start 3,047 3,054 3,034 2,602 Change in net debt 7 (20) (432) (895) Net debt at end 3,054 3,034 2,602 1,706
Balance Sheet (US$) 12/14A 12/15E 12/16E 12/17E
Assets Cash & cash equivalents 598 592 1,024 1,920 Account receivables 980 941 972 942 Inventory 1,289 1,374 1,295 972 Other current assets 0 0 (0) (0) Total current assets 2,867 2,908 3,292 3,834 Total fixed assets - - - - Intangible assets and goodwill 976 976 976 976 Investment securities - - - - Other assets (976) (976) (976) (976) Total assets 5,041 5,184 5,151 5,157 Liabilities Accounts payables 290 304 271 277 Short-term debt 0 0 0 0 Other short term liabilities 0 0 0 0 Total current liabilities 290 304 271 277 Long-term debt 3,652 3,626 3,626 3,626 Other liabilities 0 0 0 0 Total liabilities 3,942 3,930 3,897 3,903 Shareholder equity 1,099 1,254 1,254 1,254 Minority interests - - - - Total liabilities and equity 5,041 5,184 5,151 5,157 Net debt 3,054 3,034 2,602 1,706
Per share 12/14A 12/15E 12/16E 12/17E
No. of shares (wtd avg) 502 501 499 496 CS adj. EPS 1.57 1.74 1.78 2.28 Prev. EPS (US$) Dividend (US$) 0.00 0.00 0.00 0.00 Dividend payout ratio 0.00 0.00 0.00 0.00 Free cash flow per share 2.07 1.75 2.96 3.56
Earnings 12/14A 12/15E 12/16E 12/17E
Sales growth (%) 4.9 (1.2) 1.9 6.2 EBIT growth (%) 7.6 10.8 12.0 19.6 Net profit growth (%) 11.5 11.0 1.8 27.3 EPS growth (%) 11.1 11.2 2.2 28.0 EBITDA margin (%) 27.8 31.4 33.3 37.0 EBIT margin (%) 24.8 27.8 30.5 34.4 Pretax margin (%) 22.6 25.5 27.5 31.6 Net margin (%) 16.4 18.5 18.4 22.1
Valuation 12/14A 12/15E 12/16E 12/17E
EV/Sales (x) 4.98 5.04 4.85 4.40 EV/EBITDA (x) 17.9 16.0 14.6 11.9 EV/EBIT (x) 20.1 18.1 15.9 12.8 P/E (x) 26.6 24.0 23.4 18.3 Price to book (x) 19.1 16.7 16.6 16.5 Asset turnover 0.9 0.9 0.9 1.0
Returns 12/14A 12/15E 12/16E 12/17E
ROE stated-return on (%) 80.9 74.2 70.8 90.1 ROIC (%) 0.2 0.2 0.3 0.4 Interest burden (%) 0.91 0.92 0.90 0.92 Tax rate (%) 26.9 27.5 33.0 30.0 Financial leverage (%) 3.32 2.89 2.89 2.89
Gearing 12/14A 12/15E 12/16E 12/17E
Net debt/equity (%) 277.9 241.9 207.5 136.1 Net Debt to EBITDA (x) 2.3 2.0 1.6 0.9 Interest coverage ratio (X) 10.1 11.5 10.1 12.1
Quarterly EPS Q1 Q2 Q3 Q4
2014A 0.38 0.38 0.41 0.40 2015E 0.41 0.43 0.50 0.39 2016E 0.42 0.45 0.50 0.41
Share price performance
On 02-Feb-2016 the S&P 500 INDEX closed at 1903.03
Daily Feb03, 2015 - Feb02, 2016, 02/03/15 = US$43.5
Source: Company data, Thomson Reuters, Credit Suisse estimates
3 February 2016
Zoetis (ZTS) 3
Figure 1: Established, Global Leader in AH Figure 2: Companion Animal Demand Rebounding
Source: Company reports, Credit Suisse estimates. Source: Company reports, Credit Suisse estimates.
Figure 3: Strengthening Production Animal
Dynamics—USDA Cattle Inventory Projections Figure 4: Significant Profit Margin Opportunity
Source: USDA, Credit Suisse estimates. Source: Company reports, Credit Suisse estimates.
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3 February 2016
Zoetis (ZTS) 4
Executive Summary We are initiating coverage of Zoetis (ZTS) with an Outperform rating and $58 target price.
ZTS is the global leader in the development, manufacturing, and commercialization of
animal health medicines and vaccines, with an estimated $4.7 billion in 2015 revenues. It
was formed by Pfizer in 1952, and in January 2013, Pfizer spun off what was the leading
animal health business in an initial public offering, to create ZTS. Now, as a truly
independent entity, ZTS benefits from greater strategic and operational flexibility with
increased management focus, streamlined decision-making, and more optimal investment,
capital structure, and dividend policies. While it experienced some growing pains in its first
year as a standalone company, following operational and organizational shifts, with a new
CFO and a recharged board in place, new restructuring initiatives (April 2015) and several
acquisitions, ZTS has made meaningful strides that position it well for more profitable
growth in the longer term, clarity on which has also improved.
The global animal health industry is worth an estimated $110+ billion, stemming from the
sale of products and services that promote the health and welfare of production animals
(cattle, poultry, swine, sheep, and fish) and companion animals (dogs, cats, and horses).
Products include therapeutics, diagnostics, medicinal feed additives, nutritional
supplements, medical devices, and pet supplies, while services include veterinary care,
laboratory testing, and other support offerings such as data management and consulting.
Within the animal health space, therapeutics, ZTS's primary area of focus, comprises an
estimated $24 billion market, growing 4-6% annually, a run rate that ZTS should exceed on
an operational basis.
Both the animal and human healthcare markets involve an intense focus on innovation and
R&D, complex manufacturing processes, and rigorous sales and marketing efforts within a
strict and dynamic regulatory framework. However, there are several key differences
between the human health and animal health sectors that enhance the allure of investment
opportunities in the animal health sector. R&D operations are considerably faster and
cheaper, product portfolios are more sustainable, and generic drugs present only a limited
threat. Importantly, broader economic factors play less of a role in driving demand of
animal health products, leaving it uniquely resilient to macroeconomic conditions.
3 February 2016
Zoetis (ZTS) 5
Figure 5: Top Global Animal Health Companies: ZTS Is an Established, Diversified Leader in Animal Health
Source: Credit Suisse, 2014 AH Reported Sale, $ in Billions.
*Of note, there is a pending merger Boehringer and Merial's animal health businesses.
ZTS is the largest and most diversified company focused on animal health therapeutics
with market leadership in nearly all the regions in which it operates. It can leverage key
competitive advantages to gain market share, improve profitability and cash flow, and
boost ROIC. These advantages include a diversified portfolio of 300+ product lines
spanning eight core species groups and five major therapeutic categories, the industry's
largest direct sales force presence in 70 countries and less reliance on distributor partners,
and an established and expanding presence in faster-growing geographies. Given these
key advantages, ZTS is well positioned to drive future growth on better industry trends and
through several initiatives. Key growth drivers include:
Robust Industry Fundamentals
For rebounding fundamentals, we view the animal health sector as an attractive space in
health care, evading much of the associated risks that affect its human counterparts.
Strengthening Companion Animal Dynamics
Digging deeper into recent industry trends, animal health industry constituents have
reported impressive growth trends YTD, aided by growing demand for veterinary products
and services, outpacing that of the human health care market. In 3Q15, we were
heartened to see VCA, the largest standalone animal hospital chain, post one of its best
quarters in over eight years, with robust same-store sales across both its hospital (+5.4%)
and reference laboratory (+6.0%) businesses, despite difficult comps. Hospital sales were
helped by positive same-store orders (+1.6%) for the fifth consecutive quarter, following
seven years of declines, with flea-and-tick-related visits up in the double digits, an
all-important driver of patient traffic. Management commentary suggested the momentum
is continuing in a relatively warm 4Q15, an encouraging view on the heels of the robust
experiences over the past five quarters. As the largest animal hospital chain in the U.S.,
the trend bodes well for all our companion animal health names.
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Zoetis Merk Elanco Merial Bayer Boehringer Vibrac Ceva Phibro Vetoquinol
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Zoetis (ZTS) 6
Figure 6: Quarterly Utilization Trends from IDEXX and VCA
WOOF Same-Store hospital Sales and quarterly metrics reported by IDXX's information technology systems.
Source: Company reports, Credit Suisse.
Pet adoptions and veterinary prescription trends, indicators of overall pet demand, can be
barometers of performance for our companies with significant exposure to the companion
animal market. (ZTS generates 20% of total revenues within the U.S. companion animal
segment). According to Pethealth Inc., a leading provider of management software to
animal welfare organizations in North America, year-over-year growth in pet adoptions
across 1,226 animal shelters rose 5.5% in December with average growth of 6.0% over the
trailing three-month period. Cat adoptions led the gain, improving 5.6% year over year,
while canine adoptions rose 5.4%, representing a meaningful sequential acceleration. Of
note, the average price of a canine veterinary visit is ~30% higher than a feline visit.
According to Pethealth, adoptions from animal shelters represent 30% of all new pet
acquisitions in the U.S. Pet euthanasia, inversely correlated to pet demand, dropped 15%
in December, consistent with recent monthly trends, a positive for overall pet ownership.
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Zoetis (ZTS) 7
Figure 7: Monthly Pet Adoption Trends
Source: Credit Suisse.
According to IMS HEALTH, monthly total scripts prescribed by veterinarians rose 7.9% in
December, adjusted for calendar day shifts, a sequential acceleration in the trend. On a
trailing three-month basis, prescriptions increased 5.2%, rounding out 2015 with a 6.2%
increase for the year. Of note, 67% of prescriptions are dispensed at veterinary clinics. To
put the metric into perspective, human prescription declined 0.6% in December and
increased 2.3% in 2015.
Figure 8: Monthly Pet Prescription Volume, Continues to Outpace Human Prescriptions*
Source: IMS HEALTH, Credit Suisse; *Includes only medications where there is a human equivalent.
Proprietary Survey Work Points to Broader Optimism in Animal Health
In our proprietary survey of 75 U.S. veterinary practices, we assessed recent clinic volume
and revenue trends in 4Q15. As a caveat, this is only our first quarterly proprietary
veterinary survey, and the data points will likely be more relevant and indicative of industry
trends when enough historical data exist for a more robust sequential and year-over-year
comparison
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2013 2014 2015 Vet Average Human Avg (2013-2015)
Human Rx Historical Average = 2.1%
Animal Rx Historical Average = 11.1%
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Adoptions: 5.5%
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Zoetis (ZTS) 8
Based on our survey, the vast majority (79%) of respondents experienced positive patient
traffic and practice revenue growth in the latest period. On a weighted-average basis,
volume rose 1.9% and practice revenues improved 2.0%, primarily driven by increased
pricing (+1.2%), diagnostics (+1.1%), acute care visits (+0.9%), and existing patient traffic
(+0.8%). Importantly, new patient traffic was the most meaningful driver of patient visits, a
key indicator of pet ownership trends and underlying veterinary demand. Favorable
weather trends also contributed to the better experience, as noted by 15% of survey
respondents.
Figure 9: The Vast Majority of Veterinarians (79%) Experienced Increased
Volume and Revenues in 4Q15
Source: Credit Suisse.
Figure 10: Primary Drivers of Veterinary Volumes in 4Q15
Source: Credit Suisse.
Respondents (80%) were also broadly optimistic that practice volume will improve over the
next 12 months, and 87% of veterinarians expect practice revenues to also expand. While
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3 February 2016
Zoetis (ZTS) 9
ad hoc commentary suggests lingering concerns over the challenging economic
environment, the level of optimism was generally consistent with our view of a continuing
veterinary rebound.
Figure 11: Respondents Broadly Optimistic on Practice Volume, Revenue
Trends over the Next 12 months
Source: Credit Suisse.
Favorable Production Animal Dynamics—Feed the World
The production animal market is expected to grow at a 6% CAGR between 2013 and 2018
based on data from Vetnosis, as demand for animal protein rises with global population
growth. Other drivers include a need for greater productivity, with natural resources such
as land and fresh water dwindling with increasing urbanization, and heightened focus of
consumers and regulators on disease-free animal products. Currently, 40% of the global
value of agricultural output stems from the livestock sector, and 33% of arable land is
dedicated to producing feed for livestock production.
Growth in emerging markets should exceed the experience in larger, more developed
economies with the necessary modernization of the production animal infrastructure to
accommodate rising populations. New vaccines, medications, medicinal feed additives,
along with improved production animal health protocols should improve yields. Advances
in diagnostics, bovine genomics, and other diagnostic or preventative practices are areas
of potential focus for ZTS as solutions emerge and evolve to improve livestock productivity
outside of conventional therapeutics.
Figure 12: Production Animal—Projected Growth by 2023
Source: Credit Suisse.
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Dairy Cattle 1.2% 1.8%
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3 February 2016
Zoetis (ZTS) 10
Following years of contraction, the U.S. cattle herd size is poised to expand in the coming
years, according to the USDA, with improved forage conditions and lower input costs
(primarily corn-based feed), easing pressure on livestock producers. U.S. livestock
represents ZTS's largest species segment by geography (24% of revenues).
Figure 13: USDA Long-Term Projections for Cattle Herd Growth
Source: USDA, Credit Suisse.
Antibiotic Regulation: ZTS Has Limited Exposure, with Multiple Offsets
In December 2013, the FDA announced voluntary measures (GFI #213) to remove the
growth promotion label for relevant antibiotic feed additives by the end of 2016. This is
related only to medicinal feed additives used for growth promotion purposes in the U.S.
livestock industry. Of note, ZTS's global medicinal feed additives business, which includes
non-antibiotic feed additives, represents an estimated 7% of total sales; a much smaller
portion of this would be exposed to the voluntary regulation. Importantly, given many of
these products were approved decades ago, updated label changes as well as increased
preventative and therapeutic uses could be more than offsetting across the industry.
In response to consumers and public health experts advocating for more judicious use of
antibiotics in livestock, other industry constituents, including McDonald's (MCD), have
outlined initiatives to reduce antibiotic utilization in livestock. MCD plans to phase out
sourcing chicken treated with antibiotics important in human medicine for its 14,000 U.S.
restaurants. While this could be interpreted as a negative, ZTS has relatively low exposure
to relevant antibiotic categories, and there are multiple potential offsets in greater utilization
of other therapeutics offsetting coinciding lower animal yields.
Importantly, there are several caveats to MCD's provisions. It will allow the use of certain
antibiotics for treatment and prevention of disease, and its provisions will allow the use of
anticocidials (including ionophores, the most commonly used anticoccidial, representing
30% of all antibiotics used in livestock). Of note, ionophores are never used in human
medicine. MCD's provisions actually align well with the aforementioned FDA measures to
reduce the prophylactic use of certain medicinal feed additives that animal health
companies, including ZTS, have endorsed. Importantly, MCD has now potentially created a
framework that distinguishes itself from the harsher regulations of Panera and Chipotle,
recognizing the need for the treatment of sick animals and antibiotic relevance to human
medicine that others in the industry could emulate, further deemphasizing the overall
impact.
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3 February 2016
Zoetis (ZTS) 11
Innovation—Robust Pipeline of Novel Therapeutics
and Product Line Extensions
ZTS has over 400 programs in its R&D pipeline, with the majority targeting novel
technologies. Brand lifecycle management efforts will also enable ZTS to capitalize on
existing product lines by entering new markets, adding species indications, or creating new
formulations. Importantly, it requires substantially less time and resources to
commercialize a new chemical entity in animal health, given limited need for complex,
lengthy human clinical trials. Consequently, the likelihood of success is determined earlier
in the development process, making the effort more predictable, facilitating financial
decision making. A new chemical entity in animal health can be brought to market in
roughly six years under FDA regulations (or shorter under USDA, depending on type of
product), or about half the time it takes to commercialize a human drug. Associated costs
of less than $10 million do not compare with an average price of $1-2 billion to develop a
major human drug.
Figure 14: Highlighting the Inherent Efficiencies of Animal Health Drug Development vs. Human
Source: Credit Suisse, 2014 AH Reported Sale, $ in Billions.
Figure 15: Robust R&D Pipeline
Source: Company reports, Credit Suisse.
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Year 13+
Animal pK
IND Filing
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Field Trials Phase II
Field Trials
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Human Clinical Studies
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MA
NA
NIM
AL
(N
CE
, N
BE
)
Proof of concept in lab animals
SAR Chemistry, Selection of lead
In vitro
Toxicology
NADA
Research (2-3.5yrs)
Development (3.7-5 yrs)
Approval (1-1.5yrs)
Phase I, II, III (6-7 yrs) Approval (0.5-2Yrs)
EU Approval
NDA
Time to Market Number of R&D Projects
Less Than 7 years 31
4-7 years 137
Less than 4 years 275
3 February 2016
Zoetis (ZTS) 12
Highlighting New Potential Blockbusters
■ Apoquel Update—Ramping Supply: Recent launches of Apoquel and monoclonal
antibody IL-31 (under conditional USDA licensure) target the critical unmet need of
canine atopic dermatitis, representing a meaningful $150 million opportunity in 2015
with ample room for expansion as it ramps supply in 2016.
Following supply disruptions throughout 2015, ZTS expanded availability of Apoquel in
Europe in November and expanded supply in the U.S. in December. It is now better
positioned from a supply perspective in 2016, with peak annualized sales in the $300
million territory. As it ramps supply back up in the U.S., it also plans to launch in other
markets in 2016. As of January 14, ZTS has fully ramped supply of Apoquel in the U.S.
and other relevant markets. We view upside could also stem from more aggressive
pricing given its overwhelmingly high demand and pricing of alternative therapeutics.
This is consistent with commentary in our proprietary survey, which suggests
veterinarians are starting to see better supply trends of Apoquel.
■ IL-3—Rounding Out Its Atopic Dermatitis Portfolio: ZTS is also slated to receive full
USDA licensure for its new monoclonal antibody for atopic dermatitis in 2016, currently
under conditional USDA approval. According to our survey work, this type of
veterinarian-administered injectable could be used on 58% of atopic dermatitis cases, a
compelling data point suggesting potentially strong traction for the novel therapy. While
few veterinarians in our survey used the product as yet, given its conditional licensure
limiting its launch to certain, primarily specialty clinics, respondents noted its potentially
longer duration, lower risk of toxicity, superior efficacy, and less side effects as
potentially compelling advantages over standard therapy.
■ Simparica—Parasiticides Evolving: Merial (Sanofi/BI) and Merck Animal Health
shook up the $3 billion flea/tick market in 2014 with the introduction of new
prescription-only chewable flea/tick medications that replaced conventional topical
treatments. ZTS is slated to enter this new market in 1H16 with the launch of
Simparica, its new chewable companion animal parasiticide currently in development
for the treatment of fleas, ticks, and mange mite infestations in dogs.
While the companion animal flea/tick market is competitive, it represents the largest
market opportunity by therapeutic class, representing a $3 billion+ market, roughly a
third of the total companion animal therapeutics market, with substantial room for
expansion. While Merial and Merck are ahead with new oral parasiticides launched in
2014, there is room for more than two players in chewable parasiticides, in our view,
and ZTS is well positioned with its leading presence and largest direct sales force in the
industry.
Based on our survey, respondent are overwhelmingly positive on the chewable
category, with 76% often prescribing the new formulations. We view this as impressive
uptake less than two years after launch, particularly for an animal health therapeutic.
For instance, nearly one-half of respondents in our survey (49%) frequently prescribe
Merial's NexGard, the market leader in chewable flea/tick medications, generating $120
million in sales its first year. The positive reception bodes well for ZTS as it enters the
market in early 2016.
3 February 2016
Zoetis (ZTS) 13
Figure 16: High Prospects for ZTS's Upcoming Chewable Parasiticide
Simparica—Do You Prescribe the New Chewable Flea/Tick Medications?
Source: Credit Suisse (n=75).
While Simparica's potential competitive advantages have not been disclosed, the
overall flea/tick therapeutics space represents the largest segment in companion
animal health, with room for multiple players as the treatment category expands.
Greater adoption of prescription-only parasiticides can materially increase patient
compliance, veterinary practice revenues, and veterinary office visits as they are less
vulnerable to diversion. In our view, Simparica could offer a competitive advantage to
existing therapies if it better addressed palatability, GI upsdet, education, pricing,
duration, and species/therapeutic scope. While launch timing and pricing are also key
variables, we estimate Simparica could add $100 million in annual revenues, or
$0.05/share on an annualized EPS basis. Of note, some contributions from Simparica
are incorporated in ZTS's 2016 guidance. ZTS has received approval in Europe for
Simparica, and it has been filed in the U.S. with the FDA. We estimate U.S. approval in
1H16 with potential commercialization immediately thereafter.
■ Fleas + Ticks + Heartworm?—The Future of Parasiticides: Of note, Merial also
launched a combined chewable flea/tick and heartworm product in Europe, and it also
awaits U.S. approval for the product. We view this as a significant innovation,
combining two of the largest treatment areas in companion animal health, and while
this could eat at Simparica's opportunity, ZTS also has a comparable combination
chewable in development. We'd estimated this product would be two to three years
from commercialization, assuming the typical five- to seven-year development pathway
for animal therapeutics, although clarity is limited and we have not incorporated
contributions in our model at this early stage. Similar to the chewable flea/tick
dynamics, if approved in the U.S., Merial's combination flea/tick/heartworm product will
help to build the market for ZTS, although other players are likely closely eyeing the
opportunity as well.
Cost Structure Improvements Running Ahead of
Plan, Driving Substantial Operating Margin Leverage
New operational efficiency initiatives announced in April 2015 should drive over 900 bps
operating margin expansion by 2017, despite lower revenues as it rationalizes certain
regional operations (i.e., Venezuela) and unprofitable product lines. It is essentially
eliminating $300 million in costs while preserving much of its core strengths in sales force
presence and diversity by product line, species, and therapeutic class. Importantly, the
initiatives do not signal a shift away from higher-growth, more profitable product lines, and
there should be no meaningful change in its sales force positioning.
Yes, 76%
No, 24%
3 February 2016
Zoetis (ZTS) 14
The vast majority (>95%) of its pro forma 2017 sales are still expected to be derived from
geographies where it has a direct sales presence (vs. 97% previously), despite downsizing
the number of direct countries to 45 (from 70). Its proposed rationalization of ~5,000 SKUs
will only have a nominal impact of its total number of product lines, as it will target
low-growth, low-margin doses and formulations in relevant markets. All in, ZTS is targeting
34% adjusted operating margin in 2017 (from 25% in 2014), an impressive ramp in our
view. These initiatives are also incremental to its Supply Network Strategy announced in
November 2014 that calls for a 200-bps gross margin improvement by 2020.
Execution Progress
ZTS has closed/sold five of its targeted seven manufacturing facility closures quicker than
expected, driving potential profit upside in the near term. Importantly, internal expectations
assumed it would merely shut down these targeted facilities, but it was able to sell some of
the assets, generating an incremental $82 million in cash YTD. While we expect no
material financial impact from the transaction, it offers evidence it is executing on its
restructuring initiatives already embedded in our expectations.
■ On December 19, Huvepharma, a European-based animal health company, purchased
manufacturing sites and certain associated product lines for $40 million in cash. ZTS
will divest two US manufacturing sites in Laurinburg, North Carolina and Longmont,
Colorado as well as transfer the lease of a manufacturing and distribution facility in Van
Buren, Arkansas to Huvepharma. Pursuant to the agreement, ZTS will also divest
certain product lines, primarily U.S. and international livestock products including
medicinal feed additives and water-soluble therapeutics and nutritionals, representing
an undisclosed portion of its previously targeted $280 million in expected SKU
rationalization.
■ On January 5, ZTS sold a manufacturing site in Haridwar, India to Zydus Cadila for $29
million. The deal included certain product lines that were manufactured at the site,
including lower-margin medicinal feed additives, antibiotics, parasiticides, and
nutritionals sold primarily to livestock producers in India. The sale, which will close in
1Q16, coincides with a slower-than-expected consolidation of dairy operations across
India as the country focuses more on poultry.
■ On January 14, ZTS announced its pending divestiture of a manufacturing facility in
Hsinchu, Taiwan. Pursuant to the transaction, 55% ownership of the site was sold to
Yung Shin Pharmaceutical Industrial, a local animal health company, for $13 million in
cash (estimated close is in 2Q16).
Cost Structure Initiatives
- Eliminating 5,000 SKU's (from 13,000 currently)
- Consolidating 10 manufacturing facilities
- Eliminating 2,000-2,500 employees, but will maintain leading field sales force
position
- Change some of its direct/indirect selling approach (ie. Vaccines move to
distributors)
- Streamlining corporate functions, managements
- Aforementioned initatives are incremental to its Supply Network Strategy that
calls for 200 bps gross margin expansion by 2020
Upside should stem from better underlying business mix and product
launches, not fully reflected in its long-term growth profile or guidance
3 February 2016
Zoetis (ZTS) 15
Figure 17: Operating Margin 2014-19E
Source: Company reports, Credit Suisse estimates.
Targeting Higher-Growth Geographies
While ZTS is exiting certain underperforming markets, such as Venezuela, it is also
targeting certain high-growth markets, where, as it relates to its production animal
businesses, rising populations and standards of living are driving demand for animal
protein, while higher disposable incomes are leading to rising companion pet ownership
and improving standards of pet care. Of note, in 3Q15, growth across Brazil (+12%) and
China (+24%) accelerated, despite perceived tougher macroeconomic conditions across
the regions, highlighting the inherent benefits and unique advantages of the animal health
industry, which is less tied to broader economic fluctuations.
For example, in China, the consolidation of livestock, notably swine, operations across the
country has helped drive demand for more sophisticated therapeutics. Of note, in 2015, it
established new manufacturing and R&D facilities in China, underscoring its commitment
to the country and positioning it for incremental growth despite slowing GDP in the country.
25%
28%
31%
34%36%
37%
15%
20%
25%
30%
35%
40%
2014 2015E 2016E 2017E 2018E 2019E
3 February 2016
Zoetis (ZTS) 16
Figure 18: Diversified Drivers Across Geographies, Less Tied to Broader Macroeconomic Trends
Source: Credit Suisse.
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Figure 19: Global Drivers—Food Security Imperative, Global Dynamics Driving Demand for Animal Health Therapeutics
Source: Company data, Credit Suisse.
Undernutrition. The obesity epidemic
in the U.S. highlights the challenge of “food deserts” in many major cities as
well as rural areas. In a food desert, wholesome, nutritious food isn’t
available as readily as cheap, unhealthy food. (1) Making "better" calories more
affordable is essential to shifting the obesity trend.
Production
Disruptions.Avian influenza
swept Mexico’s eggindustry in 2012,
wiping out 1 in 6birds, doubling egg
prices and sparkinga national crisis. (14)
Natural resources. While
slowing, deforestationto meet food needs is
a significant concernfor long-term climate
change impact on foodproduction. (13)
Gov ernment change.
The lack of affordablebread in Egypt has, in
part, contributed todiscontent with
multiple regimes in thecountry. (12)
Changing Practices.
Fewer farmers are switchingto organic production, with
some even reverting to moreinnovative production. (2)
“You have seen a slowdownin the transition of acres,”
said George Siemon, chiefexecutive of Organic Valley,
the largest U.S. organiccooperative.
Power of Protein. The
school lunch programguidelines limiting
protein in meals at U.S.schools were reversed in
December 2013 afterparticipation dropped
because kids weren’tgetting enough protein. (3)
Rising Prices.
Egg prices in the EUskyrocketed in January
2012, when a ban onconventional chicken
cages pushed many eggproducers out of business
– egg prices in the U.K.quadrupled rapidly. (4,5) Food Shortages.
In 2013, Dutchconsumers protested a
baby formula shortagesparked by local
hoarding and il legaltrade to meet exploding
Chinese demand. (6)
Civ il Unrest. Riots
broke out in 30countries to protest
high food prices in2008, and again in
2011. (7)
Rev erse Trade. Instead of simply exporting
food from an area of production to an area ofneed, growing global economies in Asia and Latin
America are buying in to markets to protect theirlong-term food security, from land purchases in
Africa to the purchase of the largest U.S. porkproducer by a Chinese company. (8,9)
Food Security /Global
Stability. High food pricesare an ongoing threat to
civil order, warn analysts atthe New England Complex
Systems Institute, whostudied the link between food
riots and the Arab Spring.As demand climbs, so could
prices and volatility. (10)
Food Crisis Looms.
According to the WorldFood Programme, 1 in 4
people living in rural areasin Zimbabwe are expected
to need food assistance inearly 2014, the highest
since 2009. (11)
3 February 2016
Zoetis (ZTS) 18
1) WSB-TV. “Experts: ‘Food deserts’ linked to childhood obesity” July 17, 2013 2) Dimitri, Carolyn; Oberholtzer, Lydia. “Marketing U.S. Organic Foods: Recent Trends from Farms to Consumers.” United States Department of Agriculture (USDA) Economic Research Service (ERS). Economic Information Bulletin Number 58. September 2009. 3) National Public Radio “Let them eat sandwiches: USDA Eases School Lunch Restrictions” Jan. 3, 2014 4) Doward, Jamie. “Supermarkets fear egg shortage as farms close over welfare rules.” The Observer. 3 March 2012. Accessed September 23, 2013. 5) Far-center. “Un oeuf is not enough: France suffers major egg shortage.” March 2012. Accessed September 23, 2013 6) British Broadcasting Corporation (BBC). “Dutch order probe into baby milk sales to China.” May 2013. Accessed September 23, 2013 7) Lagi, Marco; Bertrand, Karla Z.; Bar-Yam, Yaneer. “The Food Crises and Political Instability in North Africa and the Middle East.” New England Complex Systems Institute. Cambridge, MA. September 2011. 8) The New York Times. “Needing Pork, China Is to Buy a U.S. Supplier.” May 29, 2013 9) Gulf News. “Land-grab phenomenon threatens Africa” Dec. 29, 2013. 10) Kharas, Homi. “The Emerging Middle Class in Developing Countries.” Global Development Outlook. OECD Development Center. Working Paper No. 285. January 2010. 11) All Africa. “Zimbabwe: Nation Faces Hunger As UN Cuts Food Aid” Jan. 15, 2014 12) The Wall Street Journal. “What Egypt Wants: Cheaper Bread.” Sept. 18, 2013 13) Kirby, Alex. “Cutting Down Amazon for Agriculture Could Cut Yields.” Scientific American. May 2013Source: Credit Suisse, 2014 AH Reported Sales (Including Non-AH Sales)
Enhanced Ancillary Service Offerings
ZTS's complementary businesses such as diagnostics, genetics, medical devices, and
services (including dairy data management, e-learning, and professional consulting) focus
on an outcomes-based approach to animal health that will be an increasingly important
growth driver. ZTS can enhance the appeal of its core offerings, leverage its
industry-leading sales force, and build customer loyalty with these capabilities, helping it to
capture incremental market share.
For example, in diagnostics, more recently, ZTS launched a new consumable rapid test for
feline viral diseases, taking advantage of recent disruptions among supply chain
constituents as diagnostics industry leader IDEXX Laboratories moved to a direct
distribution model. More broadly, ZTS can leverage its dominant presence into the single
veterinary call point as well as its distributor relationships to theoretically cross sell multiple
diagnostic capabilities, among other products and services, a unique competitive
advantage.
Figure 20: Targeted Areas of Product Development
Source: Credit Suisse.
Capital Deployment Kicker: M&A and Partnerships to
Supplement Growth
On building EPS momentum, we expect ZTS's cash reserves to grow. Its capital
deployment strategy should focus on M&A, deleveraging, and share repurchases while
remaining committed to its dividend.
Acquisitions should help ZTS fortify its existing product portfolio and development pipeline
and further build its presence in new geographies and complementary products and
services that enhance its core product offering. The company has stated interest in areas
such as devices, diagnostics, genomics, pet biotech, aquaculture, and food safety. Pipeline
deals, joint ventures, and research collaborations and partnerships may also provide it with
access to new compounds and help it develop relationships with local governments and
academia, among other unconventional sources. Overall, ZTS can enhance the appeal of
its core portfolio and build customer loyalties with these complementary offerings and
Cross Species Companion Animal LivestockComplementary
Solutions
Parasiticides Allergy/Dermatology Reproduction Genetics
Infectious Disease Sedation/Anesthesia Food Safety Diagnostics
Pain/ Inflammation Renal/ Cardiovascular Performance Biodevices
3 February 2016
Zoetis (ZTS) 19
services, helping to boost market share. Importantly, recent management commentary still
emphasized its preference for smaller tuck-in acquisitions for which there is minimal
overlap with its base business from a therapeutic or geographic perspective.
PHARMAQ: Scale-ing Up in Acquaculture—Adds a LT Growth Engine: The
acquisition of PHARMAQ on November 2 establishes ZTS as the leader in
aquaculture, enhancing its long-term growth profile. ZTS acquired PHARMAQ, the
global leader in animal health products for the aquaculture industry, for $765 million
(9.6x revenues). We view PHARMAQ as a logical extension of its livestock business,
with strong, stable revenue streams, from the fastest-growing species segment in
animal health for which medicalization rates are still relatively low. The Norwegian
company posted $80 million in revenues in 2014, with a historical base business
growth rate of 17% annually. It has 200 employees across its subsidiaries in Chile, the
UK, Spain, Turkey, Panama, Vietnam, and Hong Kong. We estimate the deal to be
neutral to EPS in 2016, but accretive thereafter. Importantly, the PHARMAQ deal
further diversifies its business, which we note is increasingly skewed toward
faster-growing segments.
Figure 21: Meat & Fishery Production, Dressed Weight or Eviscerated Basis (MM tons)*
Source: Credit Suisse, OECD and FAO State World Fisheries and Acquaculture 2012; *Total fishery production = capture + acquaculture. Beef and pork on dressed-weight basis; poultry and fish on an eviscerated basis.
PHARMAQ bolsters ZTS’s presence in the aquaculture market, worth $400 million in
2014, growing at a healthy clip (7-8% annually), compared with the broader livestock
(+6%) and companion animal industries (5%), according to Vetnosis. Farmed fish
currently represents 50% of overall fish consumption, compared with just 15% in 1990.
The deal adds key product lines such as AlphaJect (a vaccine), AlphaMax (parasiticide
for sea lice in Salmon), and diagnostic capabilities, among other products and
services. While profitability (24.8% adjusted EBITDA margin) tracks below ZTS, based
on 2014 statements, synergies could stem from leveraging ZTS’s global sales
presence, expediting geographic expansion initiatives, as well as optimizing R&D and
manufacturing, although we note cost cutting was not the impetus for the transaction.
According to specialty industry publication, IntraFish, Pharmaq is targeting rapid
expansion in key Asian markets, including China, Indonesia, Malaysia, and Vietnam.
Aquaculture is the fastest-growing segment, with production expanding from ~1 million
tons in the early 1950s to over 50 million tons today. Assessing the competitive
landscape, there are relatively few competitors participating in the famed fish market,
with PHARMAQ and Merck Animal Health as the largest, followed by smaller players
3 February 2016
Zoetis (ZTS) 20
such as Phibro Animal Health, Eli Lilly (Novartis), and Virbac. However, PHARMAQ
has a unique focus on vaccines.
New Potential Non-Antibiotic Solutions: On January 18, ZTS entered a partnership
with Australian-based Anatara Lifesciences obtaining the option to license its Detach
swine product globally, a naturally derived product extracted from pineapple stems for
use as an anti-infective and growth promotion agent in pigs.
Figure 22: Global Fish Production—The Fastest-Growing Species Segment in
Animal Health (Acquaculture vs. Capture, % Share of Acquaculture Rising)
MM Tons %
Source: OECD and FAO State World Fisheries and Acquaculture 2014, Credit Suisse.
3 February 2016
Zoetis (ZTS) 21
Earnings Outlook & Financial Resources In 2015, we forecast revenues to decline 1.2% to $4.7 billion, reflecting its exit from
Venezuela, ongoing SKU rationalization, and significant FX headwinds (-8.6%). More
specifically, we forecast U.S. operational growth (excl. FX) of 11% and international of 3%,
helped by rising underlying demand, particularly in the U.S., and recent acquisitions
(Abbott and PHARMAQ). More importantly, however, the EBITDA margin should expand
significantly by 363 bps as its first year of major restructuring initiatives (announced in May
2015) and Abbott synergies materialize. All in, 2015 EPS should grow 11% to $1.74,
despite the aforementioned SKU and country rationalization and foreign currency
headwinds.
Figure 23: Revenue Bridge—Operational Revenue Growth Targets (Excluding FX)*
Source: Credit Suisse, Company data.
We view 2016 as less reflective of its longer-term revenue growth and EPS prospects, and
we look to 2017 and 2018 as more relevant guides. Our 2016 EPS estimate of $1.78
(+2.2%) reflects the bulk of its restructuring initiatives as well as a negative impact from a
recent unfavorable tax ruling in Belgium (-$0.13). We forecast only 1.9% topline growth
with contributions from PHARMAQ and new products such as Simparica offset by
incremental FX headwinds and restructuring initiatives, including the elimination of ~5,000
SKUs. EBITDA margin expansion of 189 bps reflects a more profitable product mix through
efficiency initiatives and acquisition synergies.
More importantly, in 2017, we forecast more normalized topline growth of 6% with
increased exposure to faster-growing segments offsetting ongoing restructuring and
EBITDA margin expansion of 372 bps as efficiency initiatives begin to take hold. Net/net,
we estimate 2017 EPS to rise to $2.28 (+28%).
From a financial resources perspective, ZTS has $592 million in cash reserves and $4.5 billion in debt. We estimate ZTS will generate $432 million in cash flow from operations in 2015, which is tempered by meaningful one-time startup charges related to the Pfizer spin that will not recur.
Its trailing-12-month cash conversion cycle currently stands at 62 days, which compares with a rage of only 46-62 days for veterinary distributors in the U.S. that normally bear the working capital risk in the supply chain. High inventory balances are the culprit at 306 days outstanding, and while some of this may be more structural in nature given its exposure to the livestock industry, ongoing SKU rationalization could help to address the issue. More specifically, it could see inventory days in the 210-240 day territory on improvements in manufacturing, supply chain operations, and technological advances. In addition, with a smaller manufacturing footprint through restructuring initiatives, we would expect capital expenditures to decline to the benefit of free cash flow. All told, our free cash flow forecasts ramp significantly to $895 million in 2016, more than enough to finance its global growth aspirations while leaving ample cash for acquisitions, partnerships, deleveraging, share repurchases, and a dividend.
2015 2016 2017
Previous revenue guidance $4,700 - $4,775 $4,650 - $4,800 $4,850 - $5,050
Operational growth 6.0% - 7.5% (1.0%) - 2.0% 3.0% - 7.0%
Foreign exchange ($25) ($100) ($125)
PHARMAQ $100 $125
Pipeline + Other $100 $125
Updated revenue guidance $4,700 - $4,750 $4,750 - $4,875 $4,750 - $4,875
Operational growth 6.5% - 7.5% 3.0% - 5.0% 3.0% - 5.0%
3 February 2016
Zoetis (ZTS) 22
Figure 24: Trailing-12-Month Cash Conversion Cycle
Source: Company data, Credit Suisse estimates.
Valuation
As of February 2, ZTS's shares were trading at 16.7x our 2017 EPS estimate and an
EV/EBITDA multiple of 11.8x our 2017 forecast, a 25% and 23% discount, respective to
recent highs set in June. We do not believe the valuation fully reflects the strong animal
health industry fundamentals, the company's competitive advantages as the industry
leader, the positive news flow from recent deals and earnings reports, or the meaningful
profit opportunity in the coming years. Our $58 target price implies the stock can trade at a
16.0x EV/EBITDA multiple, a 35% premium to the stock's current valuation.
Figure 25: Price/2016 EPS Figure 26: Enterprise Value/2016 EBITDA
Source: Company data, Thomson Reuters Datastream. Source: Company data, Thomson Reuters Datastream.
Comparable Company Rationale
We also compare ZTS's valuation with a list of comparable animal health products and
services companies. On a P/E and EV/EBITDA multiple basis, ZTS's shares currently
trade well below the comparable products group average of 25.2x and 13.8x for 2017. The
list includes three different groupings of companies, either with similar business models or
that are also plays on the same attractive animal health industry growth drivers.
Accounts Accounts Average Avg. accts. Avg. accts. Inventory days Receivable days Payable days Cash conversion
Date Revenues COGS Inventory receivable payable Revenues COGS inventory receivable payable outstanding outstanding outstanding cycle
9/30/2016E $1,237 $386 $1,295 $972 $271 $4,794 $1,596 $1,339 $949 $283 306.2 72.3 64.8 313.7
6/30/2016E $1,191 $395 $1,344 $945 $277 $4,771 $1,611 $1,362 $964 $288 308.5 73.7 65.2 317.0
3/30/2016E $1,130 $378 $1,289 $906 $264 $4,755 $1,608 $1,378 $969 $287 312.8 74.4 65.1 322.1
12/30/2015E $1,236 $438 $1,374 $941 $304 $4,727 $1,601 $1,374 $974 $284 313.4 75.2 64.8 323.8
9/30/2015 $1,214 $400 $1,403 $1,038 $306 $4,811 $1,624 $1,362 $981 $277 306.1 74.5 62.2 318.4
6/30/2015 $1,175 $392 $1,417 $993 $278 $4,807 $1,643 $1,350 $997 $278 299.9 75.7 61.8 313.8
3/30/2015 $1,102 $371 $1,346 $905 $256 $4,790 $1,647 $1,336 $1,034 $299 296.2 78.8 66.3 308.7
12/31/2014 $1,320 $461 $1,289 $980 $290 $4,785 $1,642 $1,333 $1,079 $339 296.3 82.3 75.4 303.2
9/30/2014 $1,210 $419 $1,388 $1,057 $259 $4,719 $1,614 $1,321 $1,105 $394 298.8 85.5 89.1 295.1
6/30/2014 $1,158 $395 $1,336 $1,098 $337 $4,612 $1,568 $1,299 $1,116 $453 302.4 88.4 105.5 285.2
3/31/2014 $1,097 $366 $1,316 $1,100 $363 $4,568 $1,562 $1,265 $1,091 $474 295.5 87.2 110.6 272.0
12/31/2013 $1,254 $434 $1,293 $1,138 $506 $4,561 $1,584 $1,247 $1,032 $439 287.3 82.6 101.2 268.7
9/30/2013 $1,103 $373 $1,290 $1,110 $482 $4,483 $1,567 $1,251 $969 $380 291.4 78.9 88.5 281.8
6/30/2013 $1,114 $390 $1,257 $1,137 $587 $4,399 $1,536 $1,238 $906 $298 294.2 75.1 70.9 298.4
3/31/2013 $1,090 $387 $1,120 $861 $275 $4,379 $1,518 $1,241 $873 $243 298.4 72.8 58.5 312.6
12/31/2012 $1,176 $417 $1,345 $900 $319 $4,336 $1,513 $1,220 $868 $221 294.1 73.0 53.3 313.9
9/30/2012 $1,019 $342 $1,272 $848 $195 $4,287 $1,490 $1,025 $758 $183 251.2 64.5 44.9 270.8
6/30/2012 $1,094 $372 $1,172 $889 $222 $4,317 $1,505 $720 $541 $131 174.5 45.7 31.8 188.4
Trailing twelve months
15.0x
17.0x
19.0x
21.0x
23.0x
25.0x
27.0x
29.0x
Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15
P/FY2 E Average Peer average
2016 P/E: 24.2x
Historical Avg. P/E: 21.6x
Peer Avg. P/E: 25.4x
10.0x
11.0x
12.0x
13.0x
14.0x
15.0x
16.0x
17.0x
18.0x
19.0x
20.0x
Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15
EV/FY2 EBITDA Average
2016 EV/EBITA: 15.0x
Historical Avg. EV/EBITA: 14.5x
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Figure 27: Animal Health Comparable Companies Analysis
Source: Company data, Credit Suisse Estimates, Thomson Reuters Datastream.
2/2/2016 Market Avg. Daily Revenue (CY) Hist. Avg (5yr) EPS (CY) Hist. Avg (5yr) P/Sales EV/EBITDA P/E Dividend
Price Cap (mil) Vol. (000's) 2016 2017 Rev (CY) Y/Y 2016 2017 EPS (CY) Y/Y 2016 2017 2016 2017 2016 2017 Yld.
Products
Zoetis Inc $41.72 $21,391 164,055 $4,817 $5,114 3% $1.78 $2.50 39% 4.4x 4.2x 14.4x 12.2x 23.4x 16.7x 1.0%
IDEXX Laboratories Inc $71.44 $6,495 53,833 $1,711 $1,877 7% $2.16 $2.51 11% 3.8x 3.5x 18.6x 16.8x 33.1x 28.4x
Abaxis Inc $43.13 $988 9,316 $236 $260 9% $1.42 $1.54 29% 4.2x 3.8x 14.9x 13.9x 30.5x 28.1x
Phibro Animal Health Corp $33.54 $1,312 6,270 $818 $874 5% $1.90 $2.00 -93% 1.6x 1.5x 11.6x 10.5x 17.7x 16.7x 1.2%
Genus PLC $20.62 $1,303 0 $424 $449 5% $0.62 $0.69 1% 3.1x 2.9x 22.5x 20.4x 33.2x 29.7x 1.1%
Neogen Corp $52.40 $1,984 9,208 $342 $376 14% $1.14 $1.33 11% 5.8x 5.3x 23.4x 19.9x 45.9x 39.5x
Virbac SA $236.00 $1,464 1 $906 $959 8% $6.32 $8.90 -16% 1.6x 1.5x 9.2x 8.1x 37.4x 26.5x 0.7%
Vetoquinol SA $39.35 $468 0 $352 $366 4% $2.41 $2.53 4% 1.3x 1.3x 8.7x 8.2x 16.3x 15.6x 1.1%
Average 7% -2% 3.2x 3.0x 15.4x 13.8x 29.7x 25.2x
Distributors, Services & Retail
Patterson Companies Inc $42.79 $4,281 44,136 $5,676 $5,994 10% $2.64 $2.95 5% 0.8x 0.7x 9.4x 9.5x 16.2x 14.5x 1.9%
Henry Schein Inc $150.86 $12,756 74,008 $11,224 $11,724 6% $6.59 $7.28 11% 1.1x 1.1x 13.6x 12.7x 22.9x 20.7x
VCA Inc $49.90 $4,141 30,261 $2,338 $2,553 9% $2.66 $2.92 49% 1.8x 1.6x 10.9x 10.0x 18.8x 17.1x
Petmed Express Inc $17.66 $262 3,375 $233 $231 -1% $1.01 $1.05 4% 1.1x 1.1x 5.2x 5.0x 17.5x 16.9x 4.2%
Average 6% 17% 1.2x 1.1x 9.8x 9.3x 18.8x 17.3x
Pet-Biotech/other
Aratana Therapeutics Inc $3.20 $117 4,566 $9 $34 -$1.23 -$1.15 132% 12.8x 3.5x -0.7x -1.3x -2.6x -2.8x
Parnell Pharmaceuticals Holdings Ltd $2.51 $35 84 $25 $40 -$1.46 -$0.71 1.4x 0.9x -2.3x 3.2x -1.7x -3.6x
Kindred Biosciences Inc $3.40 $68 377 $1 $12 -$1.82 -$1.12 54.2x 5.8x 1.2x -1.9x -3.0x
Average 132% 22.8x 3.4x -0.6x 0.9x -2.1x -3.1x
Large-Cap Pharmaceuticals
Merck & Co Inc $50.41 $141,772 626,001 $40,505 $40,361 -5% $3.73 $3.74 34% 3.5x 3.5x 9.5x 9.7x 13.5x 13.5x 3.7%
Sanofi SA $75.27 $98,280 308,081 $37,766 $38,813 2% $5.59 $6.22 12% 2.6x 2.5x 8.7x 8.5x 13.5x 12.1x 4.0%
Bayer AG $100.35 $82,984 310,310 $48,509 $50,601 6% $7.62 $9.28 26% 1.7x 1.6x 9.2x 8.7x 13.2x 10.8x 2.7%
Eli Lilly and Co $76.30 $86,873 403,780 $21,040 $21,948 -5% $3.54 $4.07 4% 4.1x 4.0x 15.0x 13.6x 21.6x 18.7x 2.7%
Perrigo Company PLC $144.01 $21,038 292,535 $6,251 $6,710 16% $9.76 $10.84 101% 3.4x 3.1x 12.9x 11.8x 14.8x 13.3x 0.3%
Average 3% 35% 3.1x 3.0x 11.1x 10.5x 15.3x 13.7x
Total Average 6% 20% 5.7x 2.7x 10.8x 10.6x 19.2x 16.5x
3 February 2016
Zoetis (ZTS) 24
Value-Based Analysis Rationale
Based on our analysis, there is a strong documented correlation between ROIC and
valuation for our cohort of animal health companies, suggesting investors are focused
more on true economic returns. Applying our regression of enterprise value to invested
capital vs. ROIC (using FY+1 estimates) for our companies indicates that 74% of the
variation in EV/IC is determined by ROIC. This compares with a much weaker correlation
between conventional P/E multiples and EPS growth rates well below 10%. Consequently,
the ROIC correlation indicates the market is willing to pay more for companies generating
higher returns on their invested capital, not simply for stronger EPS growth.
Our ROIC forecasts are calculated by dividing net operating profits after taxes by average
invested capital. We require ZTS to earn a return on a larger capital base by adding back
reserves for doubtful accounts and other reserves, accumulated amortization, after-tax
asset related charges, and the present value of capitalized operating leases. We believe
its IPO in January 2013 sets the stage for a significant improvement in its ROIC as an
independent industry leader focused on optimizing its growth profile and cost and capital
structures.
Based on our current earnings and capital spending forecasts, we expect ZTS's ROIC to
more than double from 11.0% in 2014 to 23.7% in 2019, an impressive trajectory, in our
view. Improving profitability is the key driver, with possible upside stemming from fixed
asset and working capital improvements. Overall, our regression analysis of relevant
animal health companies' ROICs and valuations helps to support our $58 target price,
which implies a valuation higher than the line of best fit.
Figure 28: Animal Health EV/IC vs. ROIC (FY+2)
Source: Credit Suisse, Company data.
IDXX
PAHC
WOOF
ZTS
ABAX
STE
SRCL
HSIC
PDCO
R² = 0.7437
0.0
1.0
2.0
3.0
4.0
5.0
6.0
0.0% 5.0% 10.0% 15.0% 20.0% 25.0%
EV/F
Y+2
IC
FY+2 ROIC
3 February 2016
Zoetis (ZTS) 25
Discounted Cash Flow Analysis Rationale
Our discounted cash flow model assumes ZTS's profit margin ramps materially over the
next ten years. We also assume no meaningful startup costs (associated with the Pfizer
spin), and reduced capital expenditures supports our $58 valuation for the stock. Our
WACC assumption of 6.3% reflects the $4.5 billion in outstanding debt balance.
Better-than-expected profit margin growth, along with improving working capital
management, or a higher dividend payout could offer upside for ZTS.
Figure 29: Discounted Cash Flow Analysis
Source: Company data, Credit Suisse estimates.
Management Team
Source: Company Filings
Juan Ramon Alaix – CEO: Juan Ramón Alaix was appointed chief executive officer of
Zoetis in July 2012. Mr. Alaix served as President of Pfizer Animal Health since 2006,
where he was responsible for the overall strategic direction and financial performance of
the company. Under his leadership, the company generated annual revenue of $4.8 billion
in 2014 with approximately 10,000 employees worldwide. Zoetis serves veterinarians,
livestock producers and people who raise and care for farm and companion animals with
sales of its products in 120 countries.
Paul Herendeen – CFO: Paul Herendeen is executive vice president and chief financial
officer (EVP and CFO) of Zoetis. In his role, Herendeen oversees the company’s Finance
and Information Technology organizations and serves as part of the Zoetis Executive
Team, reporting to CEO Juan Ramón Alaix. Herendeen brings more than 30 years of
broad financial experience and leadership to his role at Zoetis, including 16 years as CFO
of Warner Chilcott and MedPointe.
Alejandro Bernal – EVP & Group President, Strategy, Commercial and Business
Development: Alejandro Bernal is Executive Vice President and Group President for
Strategy, Commercial and Business Development, with responsibility for new and
complementary global businesses within Zoetis.
CASH FLOWS 2014 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E
Net sales $4,785 $4,727 $4,817 $5,114 $5,405 $5,712 $6,112 $6,540 $6,998 $7,530 $8,094
Year-over-year change 4.9% -1.2% 1.9% 6.2% 5.7% 5.7% 7.0% 7.0% 7.0% 7.6% 7.5%
NOPAT $652 $936 $1,048 $1,253 $1,372 $1,513 $1,689 $1,872 $2,083 $2,332 $2,605
Year-over-year change 12.0% 43.7% 11.9% 19.6% 9.5% 10.3% 11.6% 10.8% 11.3% 12.0% 11.7%
EBITDA $1,173 $1,484 $1,604 $1,893 $2,060 $2,259 $2,506 $2,764 $3,061 $3,412 $3,796
Investment in future growth
Chg in working capital $265 ($565) ($27) $44 $39 $42 $67 $71 $76 $92 $96
Chg in fixed assets ($2) $1,179 $155 $85 ($659) $84 $63 $62 $58 $41 $38
Incremental Investment $263 $613 $128 $128 ($620) $126 $130 $134 $134 $134 $134
Free Cash Flow $389 $323 $920 $1,125 $1,992 $1,387 $1,559 $1,738 $1,949 $2,198 $2,471
Discounted cash flow
PV of FCF $389 $304 $815 $938 $1,563 $1,024 $1,083 $1,137 $1,199 $1,273 $1,347
Cumulative PV of FCF $389 $304 $1,119 $2,057 $3,620 $4,644 $5,727 $6,864 $8,063 $9,336 $10,683
Residual Value $14,231 $16,753 $20,033 $21,935 $24,192 $26,992 $29,918 $33,287 $37,274 $41,637 $41,532
PV of Residual Value $14,231 $15,766 $17,744 $18,284 $18,978 $19,928 $20,788 $21,767 $22,939 $24,115 $22,638
Corporate Value $14,620 $16,070 $18,863 $20,341 $22,598 $24,572 $26,515 $28,631 $31,002 $33,452 $33,322
Excess Cash $164 $164 $164 $164 $164 $164 $164 $164 $164 $164 $164
Total Debt and Preferred Stock $3,740 $4,500 $4,500 $4,500 $4,500 $4,500 $4,500 $4,500 $4,500 $4,500 $4,500
Shareholder value $11,044 $11,735 $14,527 $16,005 $18,262 $20,237 $22,179 $24,295 $26,667 $29,116 $28,986
Shares outstanding 501 501 501 501 501 501 501 501 501 501 501
Value per share $22.03 $23.41 $28.98 $31.93 $36.43 $40.37 $44.24 $48.46 $53.20 $58.08 $57.82
3 February 2016
Zoetis (ZTS) 26
Investment Risks Epidemiologic, Weather, Macroeconomic, Regulatory Risks: While the animal health
industry is uniquely sheltered from many of the risks of the human health care market,
including reimbursement risks, reform risks, and generic threats, which are very limited, it
does have exposure to disease threats, droughts, and other potential geographic and
epidemiologic catastrophes. Unexpected changes in weather patterns or disease
outbreaks such as canine flu, bird flu, mad cow disease, or foot-and-mouth disease can
significantly affect (both positively and/or negatively) the demand for livestock and
companion animal products.
Regulatory Risk, Antibiotics: Harsher regulations related to the raising, treatment,
processing, or consumption of livestock could cause producers to change treatment
paradigms for their herds or flocks. Potential regulations on animal medication dispensing
or surrounding any particular product line, such as medicinal feed additives, could have
negative financial repercussions. However, the inherent need to treat sick animals and
growing global demand for protein would likely mitigate the impact. In our view, antibiotics
will continue to have a role in the treatment of inevitable global disease threats and
improving the overall efficiency of livestock production while preserving animal welfare.
Cost Structure Initiatives/Manufacturing: As with many relatively new standalone
companies, there is an inherent element of execution risk, particularly as it relates to ZTS's
significant restructuring undertaking, which, if successful, should drive meaningful margin
improvement over the next several years, a key component to our positive thesis on the
stock.
Industry Consolidation Could Alter Competitive Landscape and Supply Chain
Dynamics: For example, major transactions include Eli Lilly's acquisition of Novartis's
animal health business, creating the third largest player in animal health therapeutics. In
addition, in January, Boehringer Ingleheim purchased Sanofi's Merial Animal Health
business, bolstering its exposure in companion animal and creating a more diversified
platform. However, even in light of these transactions, ZTS maintains its market leadership
positioning, and given anti-trust setbacks associated with Pfizer Animal Health's Fort
Dodge and King Animal Health mergers, we view further consolidation among the top
three competitors ZTS, Merck Animal Health, and Eli Lilly's Elanco Animal Health
businesses as unlikely.
Foreign Currency Fluctuations: While there are inherent natural hedges in a constantly
evolving global animal health market, ZTS is exposed to currency fluctuations with 60% of
its sales derived overseas. From a profit standpoint, we estimate a $100 million negative
FX impact translates into a $25 million hit to operating profit.
Activist Involvement: Pershing Square currently has an 8.4% stake in ZTS, representing
the company's largest shareholder. Pershing Square also has two board seat positions.
However, management has noted the relationship as amicable.
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Figure 30: Quarterly EPS
Source: Company data, Credit Suisse estimates.
Historical results Projections
2014 2015
31-Mar 30-Jun 30-Sep 31-Dec Total 31-Mar 30-Jun 30-Sep 31-Dec Total 31-Mar 30-Jun 30-Sep 31-Dec Total
Net sales $1,097 $1,158 $1,210 $1,320 $4,785 $1,102 $1,175 $1,214 $1,236 $4,727 $1,130 $1,191 $1,237 $1,260 $4,817
Cost of sales $366 $395 $419 $461 $1,642 $371 $392 $400 $438 $1,601 $377.69 $394.53 $385.63 $427.68 $1,586
Gross profit $731 $763 $791 $859 $3,143 $731 $783 $814 $798 $3,127 $752 $796 $851 $832 $3,232
Selling, general & administrative $305 $341 $344 $428 $1,417 $286 $309 $326 $358 $1,280 $286.84 $303 $319.51 $353 $1,262
Research & development expenses $87 $91 $93 $122 $393 $80 $83 $91 $108 $362 $83 $85 $89.02 $109 $366
Other deductions $0 $0 $0 $4 $4 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
EBITDA $339 $331 $354 $305 $1,329 $365 $391 $397 $331 $1,484 $382 $408 $443 $370 $1,604
Amortization $5 $4 $3 $3 $15 $4 $4 $4 $4 $16 $4 $4 $4 $4 $16
Depreciation $31 $33 $32 $32 $128 $48 $48 $29 $29 $154 $29 $29 $29 $29 $116
Operating income $303 $294 $319 $270 $1,186 $313 $339 $364 $298 $1,314 $349 $375 $410 $337 $1,472
Interest income $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Interest expense $29 $29 $29 $30 $117 $28 $29 $29 $29 $114 $37 $37 $37 $37 $146
Loss/(Gain) on currency exchange/other ($1) ($3) ($1) ($6) ($11) $0 ($1) ($3) ($3) ($7) $0 $0 $0 $0 $0
Pretax income $275 $268 $291 $246 $1,080 $285 $311 $339 $273 $1,207 $313 $339 $373 $301 $1,326
Income taxes $86 $76 $82 $46 $290 $78 $94 $85 $75.07 $332 $103 $112 $123 $99 $437
Net income $189 $192 $209 $200 $790 $207 $217 $254 $198 $875 $209 $227 $250 $202 $888
Net income attr. non-controlling interest $0 $3 $1 $0 $4 $0 $1 $1 $1 $3 $0 $0 $0 $0 $0
Net income available for common $189 $189 $208 $200 $786 $207 $216 $253 $197 $872 $209 $227 $250 $202 $888
E.P.S. $0.38 $0.38 $0.41 $0.40 $1.57 $0.41 $0.43 $0.50 $0.39 $1.74 $0.42 $0.45 $0.50 $0.41 $1.78
Basic shares outstanding 500 501 501 502 501 501 500 499 498 500 498 497 496 495 497
Average diluted shares outstanding 501 502 502 503 502 501 500 502 501 501 500 499 499 498 499
Tax rate 31.3% 28.4% 28.2% 18.7% 26.9% 27.4% 30.2% 25.1% 27.5% 27.5% 33.0% 33.0% 33.0% 33.0% 33.0%
Margin analysis
Net sales 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales 33.3% 34.1% 34.7% 35.0% 34.3% 33.6% 33.3% 33.0% 35.5% 33.9% 33.4% 33.1% 31.2% 34.0% 32.9%
Gross profit 66.7% 65.9% 65.3% 65.0% 65.7% 66.4% 66.7% 67.0% 64.5% 66.1% 66.6% 66.9% 68.8% 66.0% 67.1%
Selling, general & administrative 27.8% 29.4% 28.4% 32.4% 29.6% 26.0% 26.3% 26.8% 29.0% 27.1% 25.4% 25.4% 25.8% 28.0% 26.2%
Research & development expenses 7.9% 7.9% 7.7% 9.2% 8.2% 7.3% 7.1% 7.5% 8.7% 7.7% 7.4% 7.2% 7.2% 8.6% 7.6%
EBITDA 30.9% 28.6% 29.3% 23.1% 27.8% 33.1% 33.3% 32.7% 26.8% 31.4% 33.8% 34.3% 35.8% 29.4% 33.3%
Amortization 0.5% 0.3% 0.2% 0.2% 0.3% 0.4% 0.3% 0.3% 0.3% 0.3% 0.4% 0.3% 0.3% 0.3% 0.3%
Depreciation 2.8% 2.8% 2.6% 2.4% 2.7% 4.4% 4.1% 2.4% 2.3% 3.3% 2.6% 2.4% 2.3% 2.3% 2.4%
Operating income 27.6% 25.4% 26.4% 20.5% 24.8% 28.4% 28.9% 30.0% 24.1% 27.8% 30.9% 31.5% 33.1% 26.8% 30.5%
Pretax income 25.1% 23.1% 24.0% 18.6% 22.6% 25.9% 26.5% 27.9% 22.1% 25.5% 27.7% 28.4% 30.2% 23.9% 27.5%
Net income available for common 17.2% 16.3% 17.2% 15.2% 16.4% 18.8% 18.4% 20.8% 15.9% 18.5% 18.5% 19.1% 20.2% 16.0% 18.4%
Growth analysis
Net sales 0.6% 3.9% 9.7% 5.3% 4.9% 0.5% 1.5% 0.3% (6.3%) (1.2%) 2.5% 1.4% 1.9% 1.9% 1.9%
Cost of sales (5.6%) 1.4% 12.3% 6.4% 3.7% 1.3% (0.9%) (4.6%) (5.0%) (2.5%) 1.9% 0.7% (3.7%) (2.4%) (1.0%)
Gross profit 4.1% 5.3% 8.4% 4.6% 5.6% 0.0% 2.7% 2.9% (7.0%) (0.5%) 2.8% 1.7% 4.6% 4.2% 3.4%
Selling, general & administrative 2.9% 8.4% 2.1% 12.1% 6.6% (6.2%) (9.2%) (5.2%) (16.2%) (9.7%) 0.2% (2.1%) (1.9%) (1.6%) (1.4%)
Research & development expenses (3.3%) 0.0% 2.2% 2.5% 0.5% (8.0%) (8.8%) (2.2%) (11.4%) (7.9%) 3.9% 2.8% (2.2%) 0.7% 1.2%
EBITDA 7.3% 3.8% 17.2% (4.7%) 5.7% 7.7% 18.1% 12.1% 8.7% 11.7% 4.7% 4.4% 11.6% 11.7% 8.0%
Amortization 25.0% 33.3% (40.0%) (40.0%) (11.8%) (20.0%) 0.0% 33.3% 33.3% 6.7% 0.0% 0.0% 0.0% 0.0% 0.0%
Depreciation (13.9%) (5.7%) 0.0% (8.6%) (7.2%) 54.8% 45.5% (9.4%) (9.4%) 20.3% (39.6%) (39.6%) 0.0% 0.0% (24.7%)
Operating income 9.8% 4.6% 20.4% (3.6%) 7.6% 3.3% 15.3% 14.1% 10.5% 10.8% 11.5% 10.7% 12.6% 13.0% 12.0%
Pretax income 9.1% 6.3% 19.8% (1.6%) 8.3% 3.6% 16.0% 16.3% 11.0% 11.8% 9.7% 8.9% 10.3% 10.2% 9.8%
Net income available for common 5.6% 6.2% 21.6% 13.0% 11.5% 9.5% 14.3% 21.4% (1.5%) 11.0% 1.2% 5.1% (0.9%) 2.4% 1.8%
E.P.S. 5.6% 5.9% 21.1% 12.4% 11.2% 9.4% 14.6% 21.6% (1.1%) 11.2% 1.4% 5.2% (0.3%) 3.0% 2.2%
2016
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Figure 31: Quarterly Revenues
Source: Company data, Credit Suisse estimates.
31-Mar 30-Jun 30-Sep 31-Dec Total 31-Mar 30-Jun 30-Sep 31-Dec Total 31-Mar 30-Jun 30-Sep 31-Dec Total
GEOGRAPHIC SEGMENTS
US
Livestock $263 $224 $308 $368 $1,163 $299 $256 $348 $381 $1,284 $305 $264 $358 $392 $1,319
Companion $216 $235 $224 $221 $896 $222 $283 $284 $243 $1,032 $249 $300 $302 $259 $1,110
Total US $479 $459 $532 $589 $2,059 $521 $539 $632 $624 $2,316 $554 $564 $661 $651 $2,429
INTERNATIONAL
Livestock $443 $479 $482 $536 $1,940 $416 $434 $402 $434 $1,686 $399 $416 $387 $421 $1,623
Companion $164 $204 $184 $184 $736 $155 $188 $167 $166 $676 $163 $198 $175 $174 $710
Total International $607 $683 $666 $720 $2,676 $571 $622 $569 $600 $2,362 $562 $613 $562 $595 $2,332
TOTAL
Livestock $706 $703 $790 $904 $3,103 $715 $690 $750 $815 $2,970 $704 $679 $745 $813 $2,942
Companion $380 $439 $408 $405 $1,632 $377 $471 $451 $408 $1,707 $411 $498 $478 $432 $1,819
Contract Manufacturing $11 $16 $12 $11 $50 $10 $14 $13 $13 $50 $14 $14 $14 $14 $56
Total $1,097 $1,158 $1,210 $1,320 $4,785 $1,102 $1,175 $1,214 $1,236 $4,728 $1,130 $1,191 $1,237 $1,260 $4,817
MIX
US
Livestock 24% 19% 25% 28% 24% 27% 22% 29% 31% 27% 27% 22% 29% 31% 27%
Companion 20% 20% 19% 17% 19% 20% 24% 23% 20% 22% 22% 25% 24% 21% 23%
US 44% 40% 44% 45% 43% 47% 46% 52% 50% 49% 49% 47% 53% 52% 50%
INTERNATIONAL
Livestock 40% 41% 40% 41% 41% 38% 37% 33% 35% 36% 35% 35% 31% 33% 34%
Companion 15% 18% 15% 14% 15% 14% 16% 14% 13% 14% 14% 17% 14% 14% 15%
Total International 55% 59% 55% 55% 56% 52% 53% 47% 49% 50% 50% 51% 45% 47% 48%
TOTAL
Livestock 64% 61% 65% 68% 65% 65% 59% 62% 66% 63% 62% 57% 60% 65% 61%
Companion 35% 38% 34% 31% 34% 34% 40% 37% 33% 36% 36% 42% 39% 34% 38%
Contract Manufacturing 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1%
Total 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
REPORTED GROWTH
US
Livestock 7.3% 9.8% 12.0% 18.7% 12.5% 13.7% 14.3% 13.0% 3.5% 10.4% 2.0% 3.0% 3.0% 3.0% 2.8%
Companion 3.3% 0.9% 1.8% 7.3% 3.2% 2.8% 20.4% 26.8% 9.8% 15.2% 12.0% 6.0% 6.5% 6.5% 7.5%
Total US 5.5% 5.0% 7.5% 14.1% 8.3% 8.8% 17.4% 18.8% 5.9% 12.5% 6.3% 4.6% 4.6% 4.4% 4.9%
INTERNATIONAL
Livestock (3.3%) 3.5% 12.9% (0.6%) 2.8% (6.1%) (9.4%) (16.6%) (19.0%) (13.1%) (4.0%) (4.2%) (3.8%) (3.1%) (3.8%)
Companion (1.8%) 1.0% 10.8% 0.5% 2.5% (5.5%) (7.8%) (9.2%) (10.0%) (8.2%) 5.0% 5.0% 5.0% 5.0% 5.0%
Total International (2.9%) 2.7% 12.3% (0.3%) 2.7% (5.9%) (8.9%) (14.6%) (16.7%) (11.7%) (1.5%) (1.4%) (1.2%) (0.8%) (1.3%)
TOTAL
Livestock 0.4% 5.4% 12.5% 6.5% 6.2% 1.3% (1.8%) (5.1%) (9.8%) (4.3%) (1.5%) (1.6%) (0.6%) (0.2%) (0.9%)
Companion 1.1% 0.9% 5.4% 4.1% 2.8% (0.8%) 7.3% 10.5% 0.8% 4.6% 9.1% 5.6% 5.9% 5.9% 6.5%
Contract Manufacturing 0.0% 33.3% (14.3%) (31.3%) (5.7%) (9.1%) (12.5%) 8.3% 18.2% 0.0% 40.0% 0.0% 7.7% 7.7% 12.0%
Total 0.6% 3.9% 9.7% 5.3% 4.9% 0.5% 1.5% 0.3% (6.3%) (1.2%) 2.5% 1.3% 1.9% 1.9% 1.9%
Foreign exchange
INTERNATIONAL
Livestock - - - - - (9.0%) (15.0%) (17.0%) (18.0%) (15.0%) (4.0%) (4.0%) (4.0%) (4.0%) (4.0%)
Companion - - - - - (10.0%) (16.0%) (16.0%) (13.0%) (13.9%) (4.0%) (4.0%) (4.0%) (4.0%) (4.0%)
Total International - - - - - (10.0%) (15.3%) (16.7%) (16.7%) (14.8%) (4.0%) (4.0%) (4.0%) (4.0%) (4.0%)
TOTAL
Livestock (4.0%) (4.0%) 0% (4.0%) (3.0%) (6.0%) (10.0%) (10.0%) (10.7%) (9.3%) (2.3%) (2.5%) (2.1%) (2.1%) (2.3%)
Companion (2.0%) (1.0%) 0% (2.0%) (1.0%) (5.0%) (8.0%) (7.0%) (5.9%) (6.5%) (1.6%) (1.6%) (1.5%) (1.6%) (1.6%)
Contract Manufacturing (3.0%) 6% (3.0%) (8.0%) (1.0%) 3.0% (16.0%) (5.0%) (5.0%) (6.8%) 0.0% 0.0% 0.0% 0.0% 0.0%
Total FX (3.0%) (2.0%) 0% (4.0%) (2.0%) (6.0%) (10.0%) (9.0%) (9.2%) (8.6%) (2.0%) (2.1%) (1.9%) (1.9%) (2.0%)
BASE GROWTH (EXCL. FX)
US
Livestock 7.0% 10.0% 12.0% 19.0% 12.5% 14.0% 14.3% 13.0% 3.5% 10.4% 2.0% 3.0% 3.0% 3.0% 2.8%
Companion 3.0% 1.0% 2.0% 7.0% 3.2% 3.0% 20.4% 26.8% 9.8% 15.2% 12.0% 6.0% 6.5% 6.5% 7.5%
US 6.0% 5.0% 7.0% 14.0% 8.3% 9.0% 17.4% 18.8% 5.9% 10.7% 6.3% 4.6% 4.6% 4.4% 4.9%
INTERNATIONAL
Livestock - - - - - 2.9% 5.6% 0.4% (1.0%) 1.9% 0.0% (0.24%) 0.2% 0.9% 0.2%
Companion - - - - - 4.5% 8.2% 6.8% 3.0% 5.7% 9.0% 9.0% 9.0% 9.0% 9.0%
Total International - - - - - 4.1% 6.4% 2.1% 0.0% 3.1% 2.5% 2.6% 2.8% 3.2% 2.7%
TOTAL
Livestock 4.4% 9.4% 12.5% 10.5% 9.2% 7.3% 8.2% 4.9% 0.8% 5.0% (1.5%) (1.6%) (0.6%) (0.2%) 6.0%
Companion 3.1% 1.9% 5.4% 6.1% 3.8% 4.2% 15.3% 17.5% 6.7% 11.2% 9.1% 5.6% 5.9% 5.9% 8.0%
Contract Manufacturing 3.0% 27% (11.3%) (23.3%) (4.7%) (12.1%) 3.5% 13.3% 23.2% 6.8% 40.0% 0.0% 7.7% 7.7% 12.0%
Total base growth 3.6% 5.9% 9.7% 9.3% 6.9% 6.5% 11.5% 9.3% 2.8% 7.4% 4.6% 3.4% 3.8% 3.8% 3.9%
20162014 2015
Historical results Projections
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Figure 32: Annual EPS
Source: Company data, Credit Suisse estimates.
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Net sales $2,760 $3,582 $4,233 $4,336 $4,561 $4,785 $4,727 $4,817 $5,114 $5,405 $5,712
Cost of sales $983 $1,292 $1,553 $1,513 $1,584 $1,642 $1,601 $1,586 $1,639 $1,688.65 $1,736.14
Gross profit $1,777 $2,290 $2,681 $2,823 $2,977 $3,143 $3,127 $3,232 $3,475 $3,716 $3,976
Selling, general & administrative $1,026 $1,305 $1,381 $1,369 $1,329 $1,417 $1,280 $1,262 $1,212 $1,280 $1,331
Research & development expenses $365 $411 $407 $399 $391 $393 $362 $366 $371 $376 $386
Other deductions $8 $105 ($28) $0 $0 $4 $0 $0 $0 $0 $0
EBITDA $378 $469 $921 $1,055 $1,257 $1,329 $1,484 $1,604 $1,893 $2,060 $2,259
Amortization $17 $17 $20 $15 $17 $15 $16 $16 $16 $16 $16
Depreciation $42 $86 $95 $119 $138 $128 $154 $116 $116 $116 $116
Operating income $319 $366 $806 $921 $1,102 $1,186 $1,314 $1,472 $1,761 $1,928 $2,127
Interest income $3 $130 $0 $0 $0 $0 $0 $0 $0 $0 $0
Interest expense $26 $37 $36 $31 $113 $117 $114 $146 $146 $146 $146
Loss/(gain) on currency exchange $0 $0 $0 ($21) ($8) ($11) ($7) $0 $0 $0 $0
Pretax income $296 $459 $770 $911 $997 $1,080 $1,207 $1,326 $1,615 $1,782 $1,981
Income taxes $108 $183 $264 $372 $292 $290 $332 $437 $484 $535 $594
Net income $188 $276 $506 $539 $705 $790 $875 $888 $1,130 $1,248 $1,387
Net income attr. to non-controlling interest ($1) $1 $3 $0 ($0) $4 $3 $0 $0 $0 $0
Net income available for common $189 $275 $503 $539 $705 $786 $872 $888 $1,130 $1,248 $1,387
E.P.S. $0.38 $0.55 $1.01 $1.08 $1.41 $1.57 $1.74 $1.78 $2.28 $2.53 $2.82
Basic shares outstanding 500 500 500 500 500 501 500 497 494 491 489
Average diluted shares outstanding 500 500 500 500 500 502 501 499 496 494 492
Tax rate 36.5% 39.9% 34.3% 40.8% 29.3% 26.9% 27.5% 33.0% 30.0% 30.0% 30.0%
Margin analysis
Net sales 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales 35.6% 36.1% 36.7% 34.9% 34.7% 34.3% 33.9% 32.9% 32.0% 31.2% 30.4%
Gross profit 64.4% 63.9% 63.3% 65.1% 65.3% 65.7% 66.1% 67.1% 68.0% 68.8% 69.6%
Selling, general & administrative 37.2% 36.4% 32.6% 31.6% 29.1% 29.6% 27.1% 26.2% 23.7% 23.7% 23.3%
Research & development expenses 13.2% 11.5% 9.6% 9.2% 8.6% 8.2% 7.7% 7.6% 7.3% 7.0% 6.8%
EBITDA 13.7% 13.1% 21.8% 24.3% 27.6% 27.8% 31.4% 33.3% 37.0% 38.1% 39.5%
Amortization 0.6% 0.5% 0.5% 0.3% 0.4% 0.3% 0.3% 0.3% 0.3% 0.3% 0.3%
Depreciation 1.5% 2.4% 2.2% 2.7% 3.0% 2.7% 3.3% 2.4% 2.3% 2.1% 2.0%
Operating income 11.6% 10.2% 19.0% 21.2% 24.2% 24.8% 27.8% 30.5% 34.0% 35.7% 37.2%
Pretax income 10.7% 12.8% 18.2% 21.0% 21.9% 22.6% 25.5% 27.5% 31.6% 33.0% 34.7%
Net income available for common 6.8% 7.7% 11.9% 12.4% 15.5% 16.4% 18.5% 18.4% 22.1% 23.1% 24.3%
Growth analysis
Net sales 29.8% 18.2% 2.4% 5.2% 4.9% (1.2%) 1.9% 6.2% 5.7% 5.7%
Cost of sales 31.4% 20.1% (2.5%) 4.6% 3.7% (2.5%) (1.0%) 3.4% 3.0% 2.8%
Gross profit 28.9% 17.1% 5.3% 5.5% 5.6% (0.5%) 3.4% 7.5% 6.9% 7.0%
Selling, general & administrative 27.2% 5.8% (0.9%) (2.9%) 6.6% (9.7%) (1.4%) (4.0%) 5.6% 4.0%
Research & development expenses 12.6% (1.0%) (2.0%) (2.0%) 0.5% (7.9%) 1.2% 1.3% 1.3% 2.6%
EBITDA 24.1% 96.4% 14.5% 19.1% 5.7% 11.7% 8.0% 18.0% 8.9% 9.7%
Amortization 0.0% 17.6% (25.0%) 13.3% (11.8%) 6.7% 0.0% 0.0% 0.0% 0.0%
Depreciation 104.8% 10.5% 25.3% 16.0% (7.2%) 20.3% (24.7%) 0.0% 0.0% 0.0%
Operating income 14.7% 120.2% 14.3% 19.7% 7.6% 10.8% 12.0% 19.6% 9.5% 10.3%
Pretax income 55.1% 67.8% 18.3% 9.4% 8.3% 11.8% 9.8% 21.8% 10.4% 11.2%
Net income available for common 45.5% 82.9% 7.2% 30.8% 11.5% 11.0% 1.8% 27.3% 10.4% 11.2%
E.P.S. 45.5% 82.9% 7.2% 30.7% 11.1% 11.2% 2.2% 28.0% 10.9% 11.7%
Historical results Projections
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Figure 33: Cash Conversion Cycle
Source: Company data, Credit Suisse estimates.
Latest period
Accounts Accounts Average Avg. accts. Avg. accts. Inventory days Receivable days Payable days Cash conversion Cash conversion
Date Revenues COGS Inventory receivable payable Revenues COGS inventory receivable payable outstanding outstanding outstanding cycle cycle
9/30/2016E $1,237 $386 $1,295 $972 $271 $4,794 $1,596 $1,339 $949 $283 306.2 72.3 64.8 313.7 314.0
6/30/2016E $1,191 $395 $1,344 $945 $277 $4,771 $1,611 $1,362 $964 $288 308.5 73.7 65.2 317.0 319.1
3/30/2016E $1,130 $378 $1,289 $906 $264 $4,755 $1,608 $1,378 $969 $287 312.8 74.4 65.1 322.1 320.8
12/30/2015E $1,236 $438 $1,374 $941 $304 $4,727 $1,601 $1,374 $974 $284 313.4 75.2 64.8 323.8 292.4
9/30/2015 $1,214 $400 $1,403 $1,038 $306 $4,811 $1,624 $1,362 $981 $277 306.1 74.5 62.2 318.4 328.1
6/30/2015 $1,175 $392 $1,417 $993 $278 $4,807 $1,643 $1,350 $997 $278 299.9 75.7 61.8 313.8 342.5
3/30/2015 $1,102 $371 $1,346 $905 $256 $4,790 $1,647 $1,336 $1,034 $299 296.2 78.8 66.3 308.7 343.3
12/31/2014 $1,320 $461 $1,289 $980 $290 $4,785 $1,642 $1,333 $1,079 $339 296.3 82.3 75.4 303.2 265.3
9/30/2014 $1,210 $419 $1,388 $1,057 $259 $4,719 $1,614 $1,321 $1,105 $394 298.8 85.5 89.1 295.1 325.4
6/30/2014 $1,158 $395 $1,336 $1,098 $337 $4,612 $1,568 $1,299 $1,116 $453 302.4 88.4 105.5 285.2 317.2
3/31/2014 $1,097 $366 $1,316 $1,100 $363 $4,568 $1,562 $1,265 $1,091 $474 295.5 87.2 110.6 272.0 329.3
12/31/2013 $1,254 $434 $1,293 $1,138 $506 $4,561 $1,584 $1,247 $1,032 $439 287.3 82.6 101.2 268.7 248.5
9/30/2013 $1,103 $373 $1,290 $1,110 $482 $4,483 $1,567 $1,251 $969 $380 291.4 78.9 88.5 281.8 289.3
6/30/2013 $1,114 $390 $1,257 $1,137 $587 $4,399 $1,536 $1,238 $906 $298 294.2 75.1 70.9 298.4 250.1
3/31/2013 $1,090 $387 $1,120 $861 $275 $4,379 $1,518 $1,241 $873 $243 298.4 72.8 58.5 312.6 271.2
12/31/2012 $1,176 $417 $1,345 $900 $319 $4,336 $1,513 $1,220 $868 $221 294.1 73.0 53.3 313.9 294.5
9/30/2012 $1,019 $342 $1,272 $848 $195 $4,287 $1,490 $1,025 $758 $183 251.2 64.5 44.9 270.8 363.0
6/30/2012 $1,094 $372 $1,172 $889 $222 $4,317 $1,505 $720 $541 $131 174.5 45.7 31.8 188.4 307.3
3/31/2012 $1,047 $382 $1,230 $848 $200 319.8
12/31/2011 $1,127 $393 $1,063 $871 $214 267.7
Trailing twelve months
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Figure 34: Summary VBA Analysis
Source: Company data, Credit Suisse estimates.
2011 2012 2013 2014 2015 2016 2017 2018 2019
NOPAT calculation
Revenues $4,233.0 $4,336.0 $4,561.0 $4,785.0 $4,727.5 $4,817.3 $5,114.2 $5,404.9 $5,712.3
Less: Operating Expenses $3,601.0 $3,506.0 $3,741.0 $3,816.0 $3,413.0 $3,345.7 $3,353.5 $3,476.6 $3,585.2
Adjusted EBIT $632.0 $830.0 $820.0 $969.0 $1,314.5 $1,471.6 $1,760.7 $1,928.3 $2,127.2
Plus: Goodwill Amortization $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0
Plus: Increase in LIFO/Other Reserves $3.0 $20.0 ($17.0) $0.0 $0.0 $0.0 $0.0 $0.0 $0.0
Plus: Int. Exp. of Capit. Oper. Leases $0.0 $2.9 $2.9 $4.5 $4.5 $4.5 $4.5 $4.5 $4.5
Plus: R&D Expense $0.0 $0.0 $0.0 $0.0 $1.0 $2.0 $3.0 $4.0 $5.0
Less: R&D Amortization $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0
Less: Cash Taxes $141.2 $309.4 $224.0 $321.6 $382.5 $428.1 $511.9 $560.5 $618.2
NOPAT $493.8 $543.4 $581.9 $651.9 $937.5 $1,050.1 $1,256.3 $1,376.3 $1,518.5
NOPAT growth 16.7% 10.1% 7.1% 12.0% 43.8% 12.0% 19.6% 9.5% 10.3%
NOPAT margin 11.7% 12.5% 12.8% 13.6% 19.8% 21.8% 24.6% 25.5% 26.6%
Average invested capital calculation
Invested Capital - FY Start $4,828.0 $5,294.4 $5,904.3 $5,803.7 $6,095.3 $6,705.3 $6,830.3 $6,955.3 $6,335.3
Plus: Incremental Invested Capital $466.4 $609.9 ($100.5) $291.5 $610.0 $125.0 $125.0 ($620.0) $126.0
Invested Capital - FY End $5,294.4 $5,904.3 $5,803.7 $6,095.3 $6,705.3 $6,830.3 $6,955.3 $6,335.3 $6,461.3
Average Invested Capital $5,061.2 $5,599.3 $5,854.0 $5,949.5 $6,400.3 $6,767.8 $6,892.8 $6,645.3 $6,398.3
Average Invested Capital Growth 109.7% 10.6% 4.5% 1.6% 7.6% 5.7% 1.8% (3.6%) (3.7%)
ROIC calculation
NOPAT $493.8 $543.4 $581.9 $651.9 $937.5 $1,050.1 $1,256.3 $1,376.3 $1,518.5
Divided by: Average Invested Capital $5,061.2 $5,599.3 $5,854.0 $5,949.5 $6,400.3 $6,767.8 $6,892.8 $6,645.3 $6,398.3
ROIC 9.8% 9.7% 9.9% 11.0% 14.6% 15.5% 18.2% 20.7% 23.7%
WACC calculation
Debt to total adjusted market capital 4.6% 18.5% 14.8% 14.8% 20.0% 20.0% 20.0% 20.0% 20.0%
Cost of equity 8.0% 6.5% 7.1% 7.1% 7.2% 7.2% 7.2% 7.2% 7.2%
Cost of debt 3.6% 3.7% 3.6% 3.6% 3.1% 3.1% 3.1% 3.1% 3.1%
WACC 7.8% 6.0% 6.6% 6.6% 6.3% 6.3% 6.3% 6.3% 6.3%
Economic profit calculation
ROIC 9.8% 9.7% 9.9% 11.0% 14.6% 15.5% 18.2% 20.7% 23.7%
Less: WACC 7.8% 6.0% 6.6% 6.6% 6.3% 6.3% 6.3% 6.3% 6.3%
ROIC - WACC 2.0% 3.7% 3.4% 4.4% 8.3% 9.2% 11.9% 14.4% 17.4%
Times: Average Invested Capital $5,061.2 $5,599.3 $5,854.0 $5,949.5 $6,400.3 $6,767.8 $6,892.8 $6,645.3 $6,398.3
Economic profit $100.6 $208.8 $196.7 $260.4 $531.9 $621.2 $819.5 $955.1 $1,113.0
Historical results Projections
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Figure 35: Summary Valuation Statistics (Calendar Year)
Source: Company data, Credit Suisse estimates.
Historical results Projections
2011 2012 2013 2014 2015E 2016E 2017E
Price $35.00 $35.00 $31.22 $43.20 $43.05 $43.05 $43.05
Revenue $4,233 $4,336 $4,561 $4,785 $4,727 $4,817 $5,114
Price/revenue 4.1x 4.0x 3.4x 4.5x 4.5x 4.4x 4.2x
EBITDA $921 $1,055 $1,257 $1,329 $1,484 $1,604 $1,893
EBITDA per share $1.84 $2.11 $2.51 $2.65 $2.97 $3.23 $3.83
Price/EBITDA 19.0x 16.6x 12.4x 16.3x 14.5x 13.3x 11.2x
Net income $503 $539 $705 $786 $872 $888 $1,130
Diluted earnings per share $1.01 $1.08 $1.41 $1.57 $1.74 $1.78 $2.50
Price/EPS 34.8x 32.5x 22.2x 27.6x 24.7x 24.2x 17.2x
Net Income $503 $539 $705 $786 $872 $888 $1,130
Depreciation & Amortization $115 $134 $155 $143 $170 $132 $132
Incremental invested capital $466 $610 ($101) $292 $610 $125 $125
Free cash flow $152 $63 $961 $637 $432 $895 $1,137
Free cash flow yield 0.9% 0.4% 6.2% 2.9% 2.0% 4.2% 5.3%
Cash $79 $317 $610 $598 $592 $1,024 $1,920
Debt $575 $582 $3,657 $3,652 $3,626 $3,626 $3,626
Shares outstanding 500.0 500.0 500.1 501.1 499.6 496.5 493.8
Market capitalization $17,500 $17,500 $15,614 $21,646 $21,508 $21,376 $21,259
Enterprise value $17,996 $17,765 $18,661 $24,700 $24,542 $23,977 $22,965
EV/EBITDA 19.5x 16.8x 14.8x 18.6x 16.5x 15.0x 12.1x
3 February 2016
Zoetis (ZTS) 33
Companies Mentioned (Price as of 02-Feb-2016) ABAXIS (ABAX.OQ, $43.13) Aratana Therapeutics (PETX.OQ, $3.2) Bayer (BAYGn.DE, €100.35) Eli Lilly & Co. (LLY.N, $76.3) Henry Schein Inc. (HSIC.OQ, $150.86) IDEXX Laboratories (IDXX.OQ, $71.44) Kindred Bio (KIN.OQ, $3.4) Merck & Co., Inc. (MRK.N, $50.41) Neogen (NEOG.OQ, $52.4) Parnell Pharma (PARN.OQ, $2.5) Perrigo Company plc (PRGO.N, $144.01) PetMed Express (PETS.OQ, $17.66) Phibro Animal Health (PAHC.OQ, $33.54) Sanofi (SASY.PA, €75.27) The Patterson Companies (PDCO.OQ, $42.79) VCA (WOOF.OQ, $49.9) Vetoquinol (VETO.PA, €36.22) Virbac FR (VIRB.PA, €165.75) Zoetis (ZTS.N, $41.72, OUTPERFORM, TP $58.0)
Disclosure Appendix
Important Global Disclosures I, Erin Wilson, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.
3-Year Price and Rating History for Zoetis (ZTS.N)
ZTS.N Closing Price Target Price
Date (US$) (US$) Rating
20-Mar-13 33.51 36.00 N *
22-May-13 33.55 NR
23-May-13 32.84 R
* Asterisk signifies initiation or assumption of coverage.
N EU T RA L
N O T RA T ED
REST RICT ED
The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities
As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractiv e, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin Ame rican and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2 nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 1 2-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may b e assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, wh ich was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances.
3 February 2016
Zoetis (ZTS) 34
Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.
Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors.
Credit Suisse's distribution of stock ratings (and banking clients) is:
Global Ratings Distribution
Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 56% (36% banking clients) Neutral/Hold* 31% (29% banking clients) Underperform/Sell* 12% (42% banking clients) Restricted 1% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, an d Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdin gs, and other individual factors.
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Target Price and Rating Valuation Methodology and Risks: (12 months) for Zoetis (ZTS.N)
Method: Our ZTS $58/share TP and Outperform rating is based on 2017E P/E and EV/EBITDA multiples of 23.2x and 16.0x, respectively, which is more aligned with its peer group of animal health products companies and reflects optimism regarding its profit margin profile, as it separates from Pfizer. Given its underlying revenue growth profile, profit margin opportunity, and its long term ROIC potential, we view our Outperform rating as justified.
Risk: Downside risks to our $58/share TP and Outperform rating include slower revenue or earnings growth from weather-related, epidemiological, FX, or macroeconomic headwinds, execution risk to cost and capital structure initiatives, as well as activist involvement.
Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures for the definitions of abbreviations typically used in the target price method and risk sections.
See the Companies Mentioned section for full company names The subject company (ZTS.N) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (ZTS.N) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (ZTS.N) within the past 12 months Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (ZTS.N) within the next 3 months. As of the date of this report, Credit Suisse makes a market in the following subject companies (ZTS.N).
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3 February 2016
Zoetis (ZTS) 35
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