VCA Antech (WOOF) provides services that are probably among the top few priorities in the lives of many of its customers. They are an animal healthcare company that operates 606 animal hospitals serving 41 states in the USA and 4 provinces in Canada. Their laboratory network serves all 50 states and many areas in Canada. They provide veterinary services, diagnostic testing, and other solutions, in addition to selling diagnostic imaging equipment, pharmaceutical products and pet products to service providers and pet owners. Their animal hospital segment provides both general medical services such as vaccinations, neutering, etc. and advanced medical treatments. Additionally, their diagnostic services have clients including animal hospitals, veterinary practices, universities and government organizations.
Recent Performance and Valuation
The company announced earnings of $0.46 per share beating analyst expectations for a second consecutive quarter in Q2 2013. Revenue increase of 6.1% year over year was below expectations, although all business segments, including animal hospitals, labs, Sound-Eklin and Vetstreet exhibiting revenue and margin improvement.
Their diagnostics segment performed well with revenue continuing to trend up rising 5.3% in the second quarter driven by an increase both in number of requisitions and average revenue per requisition. This was accompanied by margin growth of 60 basis points to 40.8%. Since this was achieved without any increase in total number of labs it is a sign of improving performance in this segment.
Alternatively the performance of the animal hospital segment, which accounts for nearly 78% of revenue, was weaker. Revenue increased 6.7% primarily due to acquisitions, but on a same store basis growth was a much lower 1.3%. In addition, number of orders declined in Q2 while the order amounts increased. While margins expanded by 80 basis points, the margins on acquisitions were lower. Also cost cutting was the predominant reason behind improved margins, a measure which has its limitations.
At the time of writing the stock is trading at a trailing P/E ratio of over 50 which makes WOOF relatively expensive compared with its direct competitors, but the forward P/E is estimated at below 16. The stock is trading at about twice its book value with a debt to equity ratio just under 50, which is within industry norms.
Since its inception in 1986 the company has grown through a series of acquisitions which have afforded it distinctions like being the largest supplier of diagnostic medical equipment in the veterinary market. In early 2012 it expanded its business into Canada.
While total revenue for the company has grown at a compounded annual growth rate of approximately 7.4% in the last five years ending 2012, net income has declined from 2008 to 2012 by nearly $86 million. In the past few years the share of revenues attributable to animal hospitals (which is the lion's share) and other sources has increased while that attributed to the lab division has declined. This emphasizes the importance of sales improvements needed on the animal hospital side.
Total gross profit margin declined over this period from 26.8% in 2008 to 22.1% in 2012. Gross profit margin in the first half of 2013 was slightly better at 23.4%, but the remainder of the year may change that.
I came across WOOF because I was intrigued by the pet care/ veterinary services industry that it operates in. According to the 2012 U.S. Pet Ownership and Demographics Sourcebook published by the American Veterinary Medical Association (AVMA) there are approximately 70 million pet dogs and 74 million pet cats in the United States. The estimates available through American Pet Products Association (APPA) are even higher at 83.3 and 95.6 million respectively. They report that 68% of households or 82.5 million homes in the U.S. own a pet, an increase of about 12 percentage points in roughly 25 years. I think that pet ownership is likely to keep rising in the United States as it is something that appeals to many types of demographic mixes. For example, families with children are likely to want a pet, but so also are young, single people living in apartments in big cities. Alternatively, even if the demographics are changing towards an older population (as in the U.S.) the demand for companion animals may increase.
Another interesting finding in the AVMA survey was that over 63% of pet owners considered their pets to be part of the family. This puts pet care in a relatively stable "necessary spending" bracket than a "discretionary spending" bracket. It also helps that typically medical expenses on pets are a smaller percentage of owner's budgets and for companies like WOOF almost all (99% in 2012) of fees for services are paid at the time of service, minimizing collection cycles. It is estimated (source: APPA) that over $55 billion will be spent on pet care in the U.S. in 2013 up about 4% from 2012 (2008-2012 CAGR is 5.4%). Spending on veterinary services, pet care and medication (all segments in which WOOF operates) is expected to grow faster year over year at nearly 5%.
With its growing network of animal hospitals and laboratories WOOF is well positioned to take advantage of potential consolidation in a traditionally fragmented industry. It has the potential to attract more veterinary service providers, and consequently customers, who see the benefits of a large multi doctor organization that can reduce administrative, training, equipment costs for the providers and transfer the gains to customers as better care. It can also take advantage of operational efficiencies and leverage established infrastructure to realize higher margins on incremental revenue. Additionally it could continue to expand its geographical and segment footprint through acquisitions. For example, it acquired $40 million dollars in revenue through strategic acquisitions in the first half of 2013. In future it plans to acquire animal hospitals each year translating into $50-85 million dollars every year.
One of the concerns I have about WOOF is the weakness in the revenue growth of its largest segment, Animal Hospitals. While the earnings call emphasizes the great margin performance, it is based on controlling expenses, which is important but cannot be a substitute for sales growth. The good thing is that management does acknowledge this, and is committed to growing same store sales. Another concern is the reduced frequency of visits to their hospitals which may mostly be outside the control of the company if based on economic factors or better preventive care. Also due to the nature of the business, the company has to work with high fixed costs and debt burden.
Overall, I think WOOF has a good growth plan as long as it can prove itself through greater same store sales growth and continued margin expansion. It may be expensive at present but has the potential to grow earnings and prove to be a good portfolio addition. For me, WOOF is on the watch list.
Additional disclosure: I am a self taught individual investor and this article expresses my views based on my own research. I am not being influenced or paid by any organization to write this article.