Zoetis Inc. (ZTS) Earnings Call Transcript & Summary

Good afternoon, everyone. My name is Erin Wright. I'm the lead health care services analyst at Morgan Stanley. We're happy to have Zoetis with us today. But first, for more important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And with that, thanks so much for joining us today. We have CEO, Kristin Peck; and CFO and COO -- or recently appointed CFO and COO, James Saccaro with us as well today. There's a lot to get into a very pivotal time, I think, for Zoetis. So we'll go ahead and get started.

And Jay, I think you wanted to make some some intro mark, so I'll tee it up for you. And just after a long tenure at Baxter, then at GE Healthcare, why did you choose Zoetis? And now that you're kind of that month in, what are some of those initial observations since you've joined and any sort of near-term goals you can share?

Great. First of all, thanks for the invitation to the conference. We appreciate it. Thanks for those who are joining us today. We appreciate your interest in our company. For me, I was really excited about a few things. I think there's a huge value creation opportunity at Zoetis and was really excited to get after that. I also really appreciated the great management team, great CEO. And I also felt like I could contribute in terms of helping the company move forward on the journey. But really unpacking the value creation piece, from our standpoint, this is an attractive long-term growth market. I know there's been some volatility in the short term. But at the end of the day, it's a large and growing market. Zoetis is the undisputed leader with world-class products, a world-class commercial capability. And then as I looked at the opportunity, one of the things that got me most excited about it was this innovation pipeline. So we have a series of great products on the market today. But really, as we look forward to areas like CKD oncology and next-generation versions of a number of important products that we sell today. For me, it's going to unlock the next leg of growth, and I was incredibly excited to be part of that. So all of those things kind of led me to this value creation thesis, which I was excited about. I've come on board for a few weeks now. From my perspective, everything has been confirmatory so far. So no real surprises one way or the other. Passionate group of people. Perhaps that's the one thing that I underestimated. The passion of the people for the mission and the purpose of the company has been remarkable. But we have great talented individuals pipeline is as advertised. So we'll talk more about that in the coming weeks, months, quarters and years, but really excited to be there. As far as priorities, I'm new to the industry. I've been in human health for a really long time. Animal health is a little bit different. So really spending a lot of time coming up to speed on that particular area. And then also, what's the value creation agenda for us going forward. So I laid out all of those things. We have specific plans. And for me, it's about getting up to speed on each of those areas to drive it forward.

Okay. Great. And then I want to start with and kick off just because of the more recent kind of changes in shift just -- can you provide us any comments on how the quarter itself is progressing at this point? What's your confidence in the guidance that you gave at August?

Sure. I've spent a lot of time coming in, getting up to speed on guidance, obviously, since there have been quite a few short-term dynamics here. And what I would say is we're confident in the guidance that we've shared. We made certain assumptions about the market no improvement in the market and things of that nature. The market is evolving as we expected. So we feel good about the guidance, and we look forward to updating that when we see you all in November.

Okay. So digging a little bit more into that. You recently did recalibrate your operational revenue guidance to negative 3% to negative 1%. That's down from the 2% to 5% you were initially kind of forecasting the high and the low end, both reflect some sort of dollar share loss associated with some of the competitive dynamics and more proactive and targeted price actions. What does this mean in terms of kind of where the long-term growth shakes out? And how do we potentially emerge from kind of this period of pressure?

Sure. I mean I think what's important to understand are the 2 different dynamics that really drove that. And the first of those is sort of the macro of the -- where the industry is. And I think for the first time, we saw a declining pet care market, and that is just something that as those of you who covered us for a while, you really haven't seen we saw paras down 6.7% derm. This isn't us. This is the industry -- so I think looking at that sort of macro. And you talked a little bit earlier about visits being down, and that's certainly one of the contributing factors, sort of the affordability challenge for a lot of pet owners. And then more specifically, the second factor has more to do with us, which is we have been the market leader in some of the key categories that now have new competition. And in a world that's not growing, that competition, when you have close to 100% share and something like derm, it's coming out of us as you think about that new competition entering. So we did get a third entrant overall in derm against Apoquel. And we've got, obviously, a new entrant last year in the Paris category. So I think what you're seeing is intense competitive pressure. And what's historically happened in our industry as new competition centers is it expands the market. There's more people advertising, the attractiveness of a market, the big opportunity, et cetera. But what we've seen in the cleaning market is the market is not growing. And so the entrants that are there are competing for the same share overall. And I think those are the dynamics that we -- I don't think most of us expected that the market would actually move from growth to declining. And so I think that was really what some of the changes are. I'm sure we'll get into some of those details in each of the categories. But I think those are the dynamics and provided the guide of the -- at the Q2 meeting, our assumption is let's assume those aren't going to get better in the near term. I do think they will get better. So to your question, is this structural? I think a lot of this is really cyclical, and it will come back. I mean the one factor that we're continuing to watch is dog adoption and whether or not the dog market is growing. The dog market has declined for the last few years, cats are up, but cats have not been as medicalized. I don't see that as something that's going to continue forever is there one more year that we'll see. But I think, as you know, most people are looking at, we're looking at how do we get that market to grow you can get that market to grow by simply stabilizing the pets and then launching the innovation that really has differentiated us. And so what we're super excited about that I think obviously, Jay was talking about is launching that innovation pipeline and really creating new markets that don't exist today in important categories.

Okay. Great. And so one of the tactics that you're using is price, and so we get a lot of questions on that from investors. Your net price realization now is roughly in that negative 1% to negative 2% for the year, which would imply, let's say, roughly 8% price declines in the second half of 2026 for companion animal. I guess, what do you wish investors better understood about the latest pricing strategy? And how important is it for you to preserve volume? And what you know is it typically kind of brand loyal category? Are you willing to pull that price lever until you kind of stabilize volume knowing that volume would be harder to gain back?

Sure. I think there's different dynamics that we'll talk about in derm versus paras. But I think to answer your first question, what do I really hope investors understand is that this is cyclical. It's not structural. And why do I say that? Well, we're not changing our list price in neither our competitors. And our competitors have actually taken up their list price over the last few years. And so if we thought this was structural, you would see list prices coming down, and we're not. What we're seeing is, as people enter the market with new products, they always discount to get penetration, to get on shelf we certainly saw that. But when the market wasn't growing, they actually were a little more aggressive to make sure they could get on shelf. And then for those of us who are already in the market, we're needing to compete more aggressively there. But that's cyclical. If they were really -- it was structural, and there was more of a long-term challenge, you'd see people start to adjust their list prices down, but that's not what we're saying. And the focus that we have is in gross to net, which is like targeted promotions. So this isn't everybody -- 10% discount for anyone who wants to buy. This is you're buying my competitor's product today. We want to be your parasiticide of choice will give you a significant discount to switch to mine. So we know we're getting the sale when we offer it, and it has a much higher ROI. So these are very targeted promotions or not everyone gets the same thing. Same thing as you think about point of sale for the pet owner. So we think the return on investment of these promotions is just much higher than an overall change in list price or an overall promotion. So we're going to continue to make sure that we protect our share. We do think that really matters as much as we can. We know in categories like derm. Obviously, it's 100%. We'll lose share -- some share over time. But our focus is limiting that as much as we possibly can, certainly protecting it for the ones we have now, but making sure as we think about new customers, winning more than our fair share of those new customers as well.

Okay. And then the rationale for the price cuts is also two-pronged. As you mentioned, it's competition, it's also the macro component, too. But what are the latest -- how broad-based should we see some of these latest price actions, whether it's point-of-sale rebates? Will that be just on a product-by-product type of basis for consumers that would be more addressing the macro kind of friction? And then there's the -- tactics we're watching Merck and what they're doing from a bundling perspective with their derm product. Can't you just do the same?

Well, we have been doing the same, and to be honest, if you talked about over the years, we have the broadest portfolio. And in markets across the world where that is legal to do, which it is not legal everywhere to do, we do leverage our portfolio. So in the U.S., we've always had cross-portfolio programs for independent vets, the more you buy with us, the better work across categories you buy with us, the better pricing. And as I'm sure you know with our corporate, it's the same. But I think what makes our value proposition different than what some of our competitors are doing is part of the reason we get the value we do is because of our innovation. And so if you really want to get the best pricing on the new products, you need to be buying across more products. And I think this is where the strength of our pipeline really does differentiate us as we think about both those cross-portfolio programs as well as corporate contracts. I mean, I don't think anyone else is launching as many new products in as many categories, which really helps support the vet. It's a good reason for someone to come in. There's now a product for this condition that you didn't have -- you have that you didn't think there was or it's a more convenient option for them. So we really think our ability to continue to drive pet owners into the clinic is one of the strength of working with us.

And so when did you start these price actions?

You mean the targeted ones we're talking -- the targeted ones?

Yes.

Most of them were started in Q2, and then we really evolved them in Q3. I think what we learned in Q2 and these are dynamics. These are targeted programs that they are time bound. So again, it's not a list price change. So every quarter, we look at them and say, are they meeting the need? Are they achieving the results that we want and it's not, let's alter them. And I think are left and learned in Q2, as we mentioned that on the quarter was we were going to need to be more aggressive. They were -- the promotions you're running, we're not achieving the results we wanted, which is why we announced we would be more aggressive going into the second half of the year. And each quarter on this one, ours will finish in the next week or and we'll certainly then assess what we need to do for Q4, et cetera.

Okay. And so is it working? Is it -- I think that, that's one of the bigger questions that we get from investors and how is this playing out relative to your expectations? You mentioned that you're confident in the guide earlier, Jay, but are you seeing a competitive response because some of this has to do with what competitors are doing in response to what you're doing...

Yes. Well, it's a circle, like we did it based on them, they'll do it based on us. And so I think for each of us, again, as I say to people that we've met with throughout the morning, this isn't that everyone gets the same price. So like it's hard to compare promotion a promotion. So for example, if I'm going after a competitor paras, -- that's only offered if you're on my competitor's fare. So it's not like everyone is getting that offer. So I think right now, we're pleased so far. I am a frustrated optimist, as you know. So nothing is good enough as far as [indiscernible]. We'll see what we did well and then how we can make it even better as we look into it. So again, the quarter is playing out largely as we expected, as I think Jay mentioned. So there's really been no surprise offer.

And how can you leverage your corporate relationships when it comes to the competitive environment and really lean into that? Because that's something that's, I think, a competitive advantage for Zoetis.

It has been a great competitive advantage, but that competitive advantage is really in building those partnerships over many, many years. It's leading with science and innovation with them. It's helping them grow their businesses, making sure that we educate their new team members when they get there, and it's about having a broad portfolio and really walking them through the pipeline that's coming. And importantly, what it means for their practices. So we'll continue to invest heavily in those corporate relationships. We think they're important because they also help us grow the market as well. How do we make sure that we're educating on, for example, renal and chronic kidney disease, how do we start building those markets today? And the corporate partners are really important to us as we think about doing them most of them have specialty practices and GP practices, so making sure we're really spending time with those specialists to help build those markets and to help educate the GP. So we'll continue to invest both in education, portfolio and innovation with those corporate partners.

And I think you spoke a little bit on the companion animal side in terms of the macro environment. But you always have some interesting data because you look at kinetic data, you look at other data sources from a therapeutic standpoint, which are sometimes different. But how would you characterize kind of the underlying demand environment relative to maybe what you saw in the second quarter? Or at the beginning of the year, how has it evolved kind of throughout the year in terms of just core underlying demand trends across companions?

I mean I think what was different than what we expected when we started the year is slower overall in pet care in general. We can get into livestock, which action doing much better. But if you look at the U.S. companion animal side, I would say, slower overall. We're seeing where the highlights are is diagnostics, that's going great. And that's because as we talked about, when an animal is sick, they are coming in, and they are therefore doing diagnostics to treat that animal. So as we look at our business, where we're in specialty or we're in urgent or critical care, those customers are doing great, and we're doing quite well there. I think some of the greater pressure has been on more of the wellness-related categories, so parasiticide where visits were down 6.7% in the quarter is where we continue to see more of the pressure overall. And one of the strengths when you think about wellness for a while, where there wasn't a correlation for a long time between wellness visits in our business was a lot of it was going to online and retail. And that growth is still growing. That's still a double-digit grower, but it's not growing at 30% plus, which is what it was growing for us for a year. So I think retail and home delivery is still doing well. Home delivery is a little faster growing than retail today, but they're both doing well, but they're not growing at 30% overall like they were for a while. So they're double digit, but that's, I would say, a dynamic we're continuing to see. So convenience, auto ship and there's significant advantages as that get people on home delivery or on auto ship and retail because the compliance goes up dramatically, most of the time when you go there.

And the livestock market remains relatively strong. I guess anything to call out on that front in terms of your expectations there, what's embedded guide?

Yes. I mean I don't think we all would have expected double-digit growth in livestock this year, and we've had mid-single digits for many years in a row now. I think what is really driving that is GLP-1s. And the -- historically, we've seen the growth in livestock be in emerging markets as more people enter the middle class and at more protein. This is people in developed markets who are significantly increasing their protein consumption. I mean I had my core power 42 grams this morning, like many of you maybe, but I think people are really increasing their protein consumption and that is what's driving a significant increase overall in livestock. And so we're seeing that across species. The fastest-growing global species remain fish and poultry. But we're seeing great strength in the U.S. as we look at our cattle business, both around beef and dairy, et cetera. The animal price is still pretty high. They're still not retaining animals to expand the herd simply because they're getting really good dollars for those in the market today. So I think that will -- I'm not sure we're going to stay at double digit for a long time, but I think livestock is going to remain pretty strong. And I would just say that underscores, I mean we were laughing because we IPO-ed with us back then, livestock was strong and pet care was weak, and then pet care was strong and livestock was weak, and then we had an LOE. And people like get out of livestock and now livestock is growing at 10%. There's a little diversity of our portfolio that over time really does play out.

You are diversified by product line species, therapeutic class. And so let's switch gears then to parasiticide. Where does your market share stand now in terms of the combo parasiticides? And how has this evolved since the launch of a competitor or a couple of competitors, but really just one in that market, I guess, how -- what's the opportunity for future share gains in the combo parasiticide market?

Yes. We still have the leading market share for paras in the U.S. I think we're -- I think we almost doubled the next competitor there. I think that -- first, I think we have a best-in-class product. We certainly had a few year advantage. I think what's historically been driving the growth of that market is switching people from singles, from collars and from topicals into triple combinations. There's still a significant opportunity to continue to grow that market overall. So we remain excited. I think our share, I think we were up or down and they were down about 1% in the quarter, but that's a relatively stable share as we're seeing that a little loop-ins here and there overall. But we're really excited to try to get that market back to growth. There again, this is really not assuming you have more dogs, you can get that market to growth simply with converting people from collars and topicals and single agents. So we continue to be excited. And the other thing I know here is the market outside the U.S. is quite different than the market in the U.S. where we've seen much higher growth if you look at our international parasiticide business there. We just launched Simparica Trio in Brazil, for example. These are great new markets we're still launching in. So I think there's still a significant opportunity to think at parasiticide outside the United States to continue to grow those markets.

And for Trio, how much of the price actions that you're taking are towards Trio in particular?

There's different -- and again, we have different strategy. I mean what's different, again, about parasiticide is we can target who -- where are we the primary. Obviously, that's not a [indiscernible] versus where. So it's a very different competitive market there where there's been some established players actually for a long time. And that's, as you know, been extremely competitive since the very beginning, paras -- for those who are new to our industry is the single largest category in animal health and has been in the pet care side. So...

Do you think that you had a competitor that came in and did a little bit more of a land grab initially. Do you think that, that has plateaued at all in terms of your ability to -- I mean, I think you kind of mentioned it in sort of the share dynamic. Are you seeing that continue?

I don't -- we don't have an update on this quarter. But as you saw, we were, I think, down 1% in market share in the last quarter. Again, I don't think there are significant shifts that we're sort of seeing is what I would say. I mean, look, this will be an incredibly competitive market, and it will continue it's complicated, as you know, because we've got injectables here with our ProHeart 6 and ProHeart 12 as well as triple combinations and singles. So we're going to continue to launch more products into this category as well, as we've talked about -- so we look forward to continuing to grow our share and to be able to target the little submarkets that exist in parasiticides.