Markets Irrationally React To Coronavirus, Creating Buying Opportunity For Zoetis
Summary
- Zoetis released strong 2019 Q4 and Fiscal Year End earnings on February 13, 2020, beating analyst estimates.
- I adjusted my models after this recent earnings, but did not change my price target of $175.
- Coronavirus fears have driven markets to correction territory, creating a buying opportunity for Zoetis.
- New drug approval for Simparica Trio tablet will have positive effect on stock.
Zoetis Inc. (NYSE: NYSE:ZTS) is an animal healthcare company with impressive margins and significant upside potential due to recent market irrationality mispricing the company’s stock. The 52-week high/low for ZTS is $146.26 and $91.21, respectively. Currently trading at $136 (at the time of writing this article), down roughly 6% from $144.94 on Feb. 13, coronavirus fears have hit this company very hard. During the earnings call, Kristin Peck, CEO, stated, “there’s obviously some commercial risks… people are not currently bringing their pets to veterinarians… we’re watching our supply chain and are very confident we have adequate supply”.
The company beat earnings expectations, yet again, with their most recent annual report. ZTS reported quarterly earnings of $.92 per share, beating estimates of $.88 per share. ZTS also beat on revenue, generating $1.67 billion for the quarter, beating estimates by roughly 2.12%. The strong performance of ZTS can be seen in their overall outperformance of the S&P 500 and S&P 500 Pharmaceuticals Index.
Obtained from the company's most recent 10-K.
*A more in-depth analysis of their most recent reports have been included in my models below.
My Adjusted Models
I wrote my first ZTS article for Seeking Alpha on December 11, 2019. At the time of writing that article, ZTS was trading around $120 and based on my analysis, I put a long-term price target of $175 on the stock. I also priced in potential downside risk of 10%, which would have seen the stock hit around $105.
After following the company very closely over the last few months, I have continuously been adjusting my models. The three models I like to use to value companies are a comps analysis, a full-projection model, and a DCF. I have also adopted the use of a ratio analysis model, in which I compute liquidity, leverage, and profitability ratios (which I will discuss in a moment).
Created by the author using data gathered from ZTS, ELAN, and MRK Annual 10-Q's.
In this analysis, I chose to use ELAN and MRK as competitors to ZTS. All of these companies are considered large players in the animal health space and have relatively similar multiples, as shown above. However, it is still obvious that ZTS has the best opportunity to outperform based on the above information.
Created by the author using data obtained from ZTS 10-k.
Some key takeaways to mention here:
- African Swine Fever negatively impacted the company's revenue stream.
- Gross Margins remained constant between 67%-68%.
- EBIT Margins remained constant between 31%-33%.
- There was a 6% increase in EPS.
Ms. Peck, CEO of Zoetis spoke about African Swine Fever in the most recent earnings call, stating, "the market showed a dramatic shift in 2019 from African swine fever in China with at least 50% reduction in herd size according to reports... While this disease had a significant impact on our business in China last year, we see early signs of stabilization".
Even with the negative effect of the disease, their Gross Margins remained steady for YoY analysis. This is important because it shows Zoetis can generate other income from other segments of their business. It proves that the company is diversified enough to be able to maintain its impressive margins, even if things aren't always positive. The same can be said about EBIT Margins remaining constant.
A 6% increase YoY in EPS shows that the company can generate more income for its investors. This is something to watch moving forward. I have projected about 10% YoY growth in the company's EPS. This is due to a 25% growth in Profit Margin YoY. EPS is calculated by dividing Net Income by Shares Outstanding. Shares outstanding can change drastically YoY, while Net Income, for a company of Zoetis' size, will likely remain fairly consistent.
Created by the author using projected data obtained from the full-projection model.
This DCF model shows the major change in value per share from my first model. My first DCF showed ZTS shares at $132, compared to this model showing ZTS at $173.19. I have kept my price target for ZTS constant at $175, with a 3-5 year time horizon. Based on increased volatility in the markets (due to Coronavirus fears), I didn't want to change the price target at this time because it is unclear what the markets will do in the future.
Created by the author using data obtained from annual 10-K.
This model helps break down the different important ratios that investors may seek to determine if they should invest in a company. None of these ratios are frightening to me and I believe that they show that ZTS is in a strong position. I like to use this model to determine if I should look more closely at certain line items in the company's financial statements.
How Does Coronavirus Impact Zoetis?
In the earnings call, there was only one question about the Coronavirus and Ms. Peck responded by saying:
As everyone is watching, the Coronavirus is obviously emerging very quickly. As we look at our business right now, it's probably too early to tell exactly what the impact will be... First [risk] is just an overall economic slowdown, which is already driving some reduced overall consumption in animal proteins...many of [people in] our fields are not able to get out to veterinarians and many pet owners are not currently bringing their pets to veterinarians.
These two risks are the main ones in which I see having some form of impact on Zoetis in the long-term. With an economic slowdown, people will spend less money on goods/services. Recently, the travel and hospitality sectors have been hit significantly hard. This could be because people are not leaving their houses as often. This, according to Ms. Peck, has decreased animal protein consumption. People could be canceling business or leisure trips which could lead to a decrease in restaurant attendance, where people would eat steak, chicken, or poultry.
Especially in China where there were mandatory quarantines, people were not able to get to veterinarians at their convenience. This could lead to animals getting much sicker, or even dying. Veterinarians help drive Zoetis' business because they are the ones giving people the necessary medication for their pets/animals. Without veterinarians being involved in the business, Zoetis will suffer due to their products not being purchased.
An article published by Sophie Williams of BBC News describes how the Coronavirus has been affecting animals in China. This article takes a look at the disturbing effects the Coronavirus has on animals.
Simparica Trio Tablet Approved by FDC
According to the Zoetis website, the new Simparica Trio Tablet is "the first all-in-one protection in the U.S. against heartworm disease, ticks and fleas, roundworms, and hookworms in a single monthly chewable". This is very big for the parasiticide community, especially for dogs because it "protects against many of the most common parasites and gives veterinarians and pet owners a convenient option for comprehensive protection".
This new medicine developed by ZTS also shows that they are continually funding their R&D programs. To continue to be ahead of the competition, ZTS has to innovate and develop their products. Since 2017, ZTS has increased their R&D funding by nearly 20%, which speaks to the release of the Simparica Trio Tablet.
I believe with the release of this new medicine, it will only continue to keep ZTS in the number 1 position in the animal healthcare space. When companies have exposure to FDA approval decisions, it can severely drive stock prices. Due to the recent market volatility, we didn't see that as much, but the stock did rebound on the announcement. The stock was trading at $132 at the time of the announcement and bounced to around $135 on the positive news.
On the other hand though, if the medicine would not have been approved, we could have seen the stock go lower. This is always a risk when investing in a company that has exposure to FDA decisions. However, because ZTS is such a large, established company, I do not think we will see severe volatility in the stock price around these decisions like we see with some of the smaller biotech companies. This is because a lot of the smaller biotech companies are trying to get one big product to the market and if they fail, investors don't have as much faith in them.
Possible Risks
With my bullish sentiment on ZTS, it is important to consider some risks associated with a long position. The first major risk would be that the Coronavirus would have a significant impact on business in China for the foreseeable future. This will cause ZTS to lose potential revenue across their business segments in China. If the Coronavirus continues to have major impacts on the world, people may not be able to care for their pets by taking them to veterinarians. If this risk were to happen, investors could see the stock price of ZTS to drop. With fewer people able to take their pets to veterinarians, it could mean fewer products being sold. This will hurt the company's revenue streams.
Another possible risk associated with this is that the possible loss of revenues could cause the company to cut dividend payments. I find this very unlikely for a few reasons. First, the company recently announced a dividend increase from $.16 to $.20. Also, based on my above financial statement analysis, I believe the company will be able to have ample cash on hand to fund R&D projects and pay dividends to investors.
Summary
Based on the most recent earnings report, hearing Ms. Peck speak on the earnings call, and the release of the Simparica Trio medicine, I remain bullish on ZTS, keeping my price target steady at $175. This price target signifies about 30% upside potential for the company. I think that for the time being, the Coronavirus fears will continue to have an impact on the company. However, I believe that current trading levels signify a great buying opportunity for investors to get into this company. With a strong past and a projected strong future based on my analysis, I believe the Coronavirus fears will pass and the stock will continue soaring once again.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ZTS over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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