Stocks in the pet medicine space have been on a tear over the last year and are trading near 52-week highs. We believe the investment thesis for pets is secular in nature and we are presently taking advantage of a slight dip in one stock in particular – IDEXX Laboratories (IDXX).
IDEXX Laboratories makes diagnostic kits to test your pet for diseases. The $3.4B company out of Maine possesses one of the more interesting, and higher margin, business profiles in the group. Rather than play the sector via a retail name like Petsmart (PETM), we think investors would be wise to turn to the diagnostic end of the sphere. Below are IDXX's sales for the last 5 years – as one can see, they have been on a roll. And they have been doing so profitably!
Herein we list some of the more salient points behind IDXX's stock, which has shown healthy double digit earnings growth over the last couple of years.
IDXX is taking advantage of a continued secular trend of increased utilization of more complex veterinary services for pets. Six out of ten households own a pet; Americans are throwing more of their disposable income to their fuzzy companions In the trailing 12 years, spending on pets has doubled from $17B to $39B. We expect the trend to continue given the rising popularity of pets among celebrities, baby boomers, and single young professionals. The trend among animal hospitals/vets is moving towards (internal) kits (and away from outsourcing to labs). Razor/blade business model based on consumables = steady annuity of income; creates robust 22% EBIT margin IDXX sells to veterinarians (vs. consumers), a group that faces higher switching costs and thus creates less fickle revenue for IDEXX. IDXX has jettisoned some of its pharma business, which was consuming cash and getting them nowhere fast. Aggressively buying back stock
Our back of the envelope EPS for 2008 is $4, reflecting 19% growth and in line with historical performance. We think a fair value for IDXX is in the $100 range, which we derive by taking our $4 estimate and applying a 25x PE (mid range of 5Y 20-37 range). At present levels, we rate Idexx a HOLD and would use dips in the stock to accumulate a position. IDEXX may not be a screaming buy, but it's certainly not a dog to ignore. At a better valuation, we'd open up our wallets and gladly join the Pet Economy.