Zoetis Inc. (ZTS) Earnings Call Transcript & Summary

Good afternoon, everybody. I'm Chris Schott at JPMorgan, and it's my pleasure to be introducing Zoetis today. From the company, we have Kristin Peck, the CEO; as well as Wetteny Joseph, who's going to join us for some of the Q&A after the presentation. As a reminder, we've moved away from the formal breakout sessions at the conference this year. So post the presentation, we're going to do some Q&A from the stage. And with that, I'm going to turn it over to Kristin. Happy New Year, and thanks for joining us.

All right. Well, it is great to be back. Thank you very much, Chris, especially to be back in person and to see so many familiar faces. Before we get into the real front of the day, we got some legal housekeeping. So why don't I kick into that for a second. As you can probably imagine, we're going to have some forward-looking statements today as well as financials that are non-GAAP. The reconciliations of which you can find in our presentation today as well as on our website under the SEC Filings section. So with that, let's have some fun. So if there's anybody in the room who doesn't know Zoetis, I thought it might be a good place to start. And at Zoetis, we're incredibly purpose-driven, and we see our purpose to nurture the world and human kind by advancing care for animals. We do this by providing a wide range of products from vaccines and medicines to diagnostics and devices, to customers that range from veterinarians, livestock producers as well as pet owners around the world. And as you look at this year, our guidance that we gave out in November is to generate revenue of $8 billion to $8.75 billion and operational growth of 7% to 8%. So as we think about today's presentation, there are 5 takeaways I want to leave you with. The first is that animal health, the fundamental drivers of which remain incredibly strong. And as I'll talk about today, they've been strong over time even in uncertain times. The second is around Zoetis, that our market leadership is built on a diverse, durable and innovation-driven portfolio that has a very long life with some compelling franchises that I'll speak about. And this portfolio has given us financial strength to continue to invest in our business and to grow our business. And I'll outline some of those key areas there that will not just allow growth, but profitability over time and that we're strategically positioned to expand in some of the largest and fastest-growing markets across animal health. And what has this done for you, our shareholders? Our proven track record of performance has allowed us to deliver significant total shareholder returns since we IPO-ed, and I'll talk about a little bit this later, about 10 years ago. All right. So let's jump into the industry. So Zoetis operates in the animal health industry, which is around $45 billion. It's in all the sections I spoke about before, medicines, vaccines, diagnostics, biodevices, genetics, et cetera. And as you look at this graph, over time, over the last 10 years, you can see that the growth in the industry overall is averaging about 5.8%. Those are through different economic times, through different disease outbreaks, different challenges with weather in our industry. And if you look in the bottom, even as you look at the last recession, the industry still grew at 2.6%. So we're an industry that's incredibly resilient. We're not like impervious to economic challenges, but we weather them much better given the fundamental drivers of our business. So let's start on the first driver, which has to do with the fact that animal health is quite different than human health. So as you look here, the first thing you'll notice about the animal health business is that we have direct access to the decision makers. We sell to the livestock producer or to the veterinarian, and they actually purchase our product. And we have a much more consultative approach. Many times in human health, you can measure your visit in maybe one hand, 3 to 5 minutes. We spend extended periods of time, and we're truly a trusted partner to our customers. The second major difference is that it's a self-pay model. We don't really sell through governments. There's no third-party providers. So when we sell our products, we sell them based on outcomes and value. So we have a much better sense of what the market is going to be for our product based on the outcomes we can deliver for either the pet or the animal when it comes to livestock. The next thing that's different is we have incredibly cost-effective R&D. And the reason for that starts with the fact that we begin research in the species that we're going to create the product for. So it's faster on average, 2 to 3 years faster than you'll see in human health. It's also much more cost effective. It's a real compelling difference between animal health and human health. And the last thing that's really different in animal health than human health is the diversity of the business. There's certainly the diversity of species, Zoetis, for example, operates across 8 different species. It's also the diversity of the markets. So even when one market is up or down or there's a weather event in one market or another, it has allowed the industry and Zoetis through different challenges to weather them much more effectively than many other industries. So as you look at that, we can start on the animal health side in livestock. So what is the primary driver for livestock? It's protein consumption. So today, across the globe, there's about 8 billion people on this planet. It's expected to grow to about 10 billion by 2050. So what does that mean? That means the world is going to have to produce protein that should increase between 50% and 70% to meet that need. It also means in an environment where we need to be producing more, we need to do it in more sustainable ways. We need to find ways to keep animals healthier and more productive. And that really comes into the unique position we have at Zoetis to create those solutions, whether that be in poultry or aquaculture, the need for sustainable agriculture production of protein is one that's going to continue to grow. We often get questions around, well, can't you get that with alternative proteins. They're growing, but they remain incredibly small. And many people try them. It's still the significant primary protein source for people around the world today, and I believe in 2050 will be animal-based proteins. That may shift and we often see this across the livestock industry. So in difficult economic times, people may trade proteins, they may trade between beef to pork or pork to chicken or chicken to eggs or dairy, but they're still consuming protein. And that is a sustainable macro driver that will continue to drive animal health. Next, let's focus on the pet care side, and I'm sure anyone who's in this room has seen the big pet care boom over the last few years. But there's a number of trends I want to talk about that have been driving the industry not just since COVID, but long before it. The first is that pet owners are prioritizing the health of their animals even more. And some of this is driven by who is generating that demand. And that 50% of pet owners today are millennials and Gen Z. And the fact is they see their pets differently. They're much more important parts of their family. They do lots more research. They're much more willing to spend on their pets. We're also seeing a lot of the pets that are being adopted, being adopted by high-income families that often have more than one pet. And the big question we're getting in the one-on-ones this morning and that we've been getting over the last few months is, well, what happens if there is an economic recession? Are people going to stop spending on their pets. So we did a study at Zoetis. And the reality was, in a hypothetical situation where a family was facing a 20% reduction in their annual income, they wouldn't change the investment in their animal's health care costs at all. And part of the reason why is that animal health care costs are only 0.87% of a household spend. So it's very small. So even if it went up a little bit, it doesn't have a significant impact. But the loss of that pet on the family dynamics has immeasurable. And this has been supported by other organizations, such as the Human Animal Bond Research Institute, as you see on the left-hand side of the slide, where 86% of pet owners said they would spend whatever it takes to take care of their pet. So the other dynamic we get a lot of questions on from investors is around vet clinic dynamics. So what's happening there? We've seen a lot of different trends between 2020, 2021 and 2022. So what I wanted to share today is some longer-term trends, so you can put some of this into context. So if you look at vet clinics, there's 3 things we really take a look at: overall revenue, spend per visits and overall visits. And as you can see here beginning in 2018 quarter-by-quarter through today, all 3 lines have an upward trajectory. There are -- anything that happens in any given quarter that makes one significantly more than another. And there's no question in 2021 that you saw significant increases given a lot more pets were adopted, a lot of those pets were puppies, there was a lot more visits, et cetera. But what we're seeing, even if you look at the 3Q data is revenue per visit, is still up 9%. Overall revenue is up 5%. But we've seen as some slight declines overall in vet clinic visits. And there's a few causes of this. The first and foremost is some of those puppies are now dogs, they need to go less frequently. But if you do have a dog that's no longer a puppy and you try to get an appointment with your vet, I guarantee you'll find out that it's going to take you a few weeks or a month to get that visit. And that's become -- there's been some challenges in the capacity of vet clinics. Some of this is they got burnt out, honestly, doing what they did in 2021. They just didn't want to do it anymore. And some of it is they had great turnover in their practices. We've seen this overall in many sectors of the economy, whereas everybody said, "I want to make more money. I don't want to have to go with physical presence required job." And they lost a lot of techs, and they lost a lot of their front-office staff. And we couldn't just produce more vets overnight to meet this need that we saw. But I think the really important thing for you to focus on is the pet owner demand is there. The decline in vet visits isn't that the pet owners don't want to see a vet. They absolutely want to see a vet. It's there's a limited capacity. And what we're starting to see -- and I was out with vet clinics in the last few months in the U.S. and in Brazil and in Chile. And this is a global trend, by the way, is it vet clinics are starting to figure out how to address it. Part of this is have a more leveraged model, right? Maybe instead of 1 vet, 1 vet tech, maybe it's 1 vet, 3 vet techs, and I can make use of my time much more efficiently. And I think this is what you're going to continue to see. The really important thing is, as you look at revenue overall and spend per visit, it's up 25% since 2018. So the industry remains strong. Pet owner demand remains incredibly strong. So let's talk about what this means overall for Zoetis. The first is that we have a diverse, durable and innovative-driven portfolio. And we've had this over many, many years. It allows us to have steady performance across a myriad of different economic and macro environments. We do this across 7 therapeutic areas, as I said before, 8 species. We have 15 blockbuster products, which in animal health are defined as products over $100 million. The average market life of our product is 30 years. We have 300 product lines. And really, this is driven by an R&D engine that is incredibly productive. We invested in 2021 around $500 million. In 2022, our guidance is around $530 million to $540 million for our R&D spend. And we've been one of the most productive R&D engines in the industry, bringing disruptive innovations such as the first, the second and the third monoclonal antibody in the industry from Cytopoint for atopic dermatitis, to Librela for osteoarthritis pain in dogs, to Solensia in cats. We are the world leader. As you look at Simparica Trio, the first company in the U.S. to bring a triple combination product. But we also do this with life cycle enhancements, whether that's in companion animal or livestock. Apoquel Chewable, for example, formulation as we've launched in Europe or DRAXXIN KP; or in singles, which are additions to vaccines and livestock with our Procerta family of vector vaccines or new products for cattle, the R&D engine of Zoetis is incredibly strong. And this innovation that we've led helps us drive growth above and beyond the market. And the clearest way to see this is in the world-leading franchises that we have built in some of the biggest sectors in animal health. So as you start on the left-hand side of this page, for those of you who've been with us for a while, we created the dermatology space in animal health. Back in 2012, the animal health dermatology market was around $70 million. Today, it's $1.25 billion, of which we're $1.2 billion of it. So that was even in 2021. We did this by creating a market by better understanding what the customer needed and then helping build that market through vets as well as in direct-to-consumer advertising. And we believe we can continue to grow the dermatology market. We can grow it by expanding geographies outside of the United States, where the usage is still significantly less than it is in the U.S. But even in the U.S., there's still 6 million untreated dogs. So we believe we can continue to expand that market. We invest in this heavily through direct-to-consumer advertising. The second is the biggest market in animal health is our franchise across parasiticides. Parasiticides in the world is around a $6 billion market. And over the last 3 years, it's growing around 13%. But if you look at what Zoetis has done with Simparica, Simparica Trio, ProHeart Revolution, Rev Plus, no matter where you are in the world, no matter how you practice as a vet, we have the product that your customer needs. It's a franchise. We look at it holistically. And as you see here, we have a $1.3 billion business, growing at 45%. It's an incredibly exciting space, and we're very excited about the potential growth of parasiticides. And last is sort of the place we're disrupting most right at the moment, which is the pain category. Historically, the pain category in dogs and cats combined has been somewhere around a $500 million market. We believe with the addition of Librela for dogs and Solensia for cats we can grow that market to over $1 billion with our innovation. We were -- it's really had historically been NSAIDs. We were the leader in that with our product, Rimadyl, which is part of our franchise. But we really think this is disruptive innovation that we're going to bring to pretty much double our market. And this is what Zoetis has continued to do over time. We are the world leader, not just as you see by species, where across our largest 4 species, there was a 90% of our revenue, we are #1. We're #1 in the dermatology space with our franchise there, #1 in pet pain and #2 in parasiticides. Our leadership is across geographies, it's across species and it's across product categories. And what this has helped us to do is to invest in the growth for our future. Obviously, our primary investment is always inside of our company. It's going to be in R&D. I've spoken about our significant investment in 2021 and 2022. And what should you expect for 2023? Even faster growth in our R&D spend given the strength of our pipeline. But we're also investing internally in other spaces in direct-to-consumer advertising, supporting some of our biggest franchises, whether that be in dermatology with Apoquel and Cytopoint, certainly our paras across our whole broad franchise. But we're also looking at that now with pain with Librela and Solensia outside the U.S. and unbranded. And as we grow in the U.S., we'll be building direct-to-consumer campaigns there as well. So the pet owners are aware of our products, and they go to their veterinarians asking for it. We're also investing in supply. Given the strong growth that Zoetis has had over time, we need to continue to expand our capabilities there as well as in really important spaces such as monoclonal antibodies, whereas, again, we've had the first, second and third there. And we have a strong pipeline of monoclonal antibodies behind that. And we are the world's leader, not just in research and development, but the ability to scale monoclonal antibodies for a market that self-pay to be able to reliably do that. We're investing heavily there as well as in many other important platforms for our parasiticides, for derm, you name it. We've got expansion of facilities in the U.S., in Ireland. We've expanded with new acquisitions in Australia as well as expansions in China. We're also investing in sustainability, which we think is critical to our success as a company in the future. We've made commitments to be carbon-neutral by 2030 as well as 100% renewable energy. We have very specific plans in place to meet these targets, and importantly, to support our customers for which sustainability remains a really critical imperative. But given our financial strength, we still have the ability to continue to invest in business development, whether that's external alliances, partnerships or acquisitions. We were excited last year to close 2. The first one was Basepaws in the pet care genetic space. So if you've got a cat, hopefully, you're a customer of Basepaws. We'll be expanding into dog there as well; as well as the acquisition of Jurox, an animal health company based out of Australia, but that sells around the world that's both in livestock and companion animal. And we've done all this while still returning our excess capital to our shareholders. We've done this in the first 3 quarters of 2022 with $1.2 billion in share buybacks and a committed quarterly in 2023 to increase our dividend about 15%. And as we look into 2023 and really the foreseeable future, we see 5 major growth drivers that will help us continue to drive above-market growth. We've talked about companion animal parasiticides. As we're back in full supply in this quarter, we expect to continue to grow that market significantly. And our key dermatology portfolio, which remains a significant franchise for us, that we're going to continue to grow. In osteoarthritis pain, we are basically establishing the new standard of care. And global diagnostics, which is a fast-growing space that we're in, it grows at double digits. It's a $4 billion market. As we complete and lap our go-to-market new model in the U.S., we're really excited to see the growth there, but importantly, outside of the U.S., which is growing even faster. And lastly, is emerging markets. If you go back to those trends I talked about in the beginning, whether that was livestock or companion animal, both are critical in emerging markets. That's where that new population growth of $2 billion is kind of primarily be coming from, so protein and livestock. But pets are becoming much more important. A great demonstration of that is China, which our business today is 50% livestock, 50% companion animal. So both of those pet and livestock trends are critical to growing in emerging markets. So as I reflect, in 3 weeks, Zoetis is going to celebrate our 10-year anniversary as a public company. I know some of you in the room, I can see were with us way back when in 10 years ago when we IPO-ed. We were really the first large animal health company. Kind of nobody knew -- I remember talking back then, nobody really knows this animal health space. We were about $16 billion on our market cap when we IPO-ed. Today, we're somewhere around $70 billion. We had $4.6 billion in revenue. We're now over $8 billion. Importantly, as you think about where we are today and where we're going is when we IPO-ed, companion animal was only about 36% of our business. Last year in 2021 or a little over a year ago, it was over 60% and growing quickly. These are fundamentally important as we think about our growth going forward because companion animal tends to be more resilient in challenging times than livestock is. We've improved our operating margins from 24% to 38%, our revenue-per-colleague. And I want to pause there on the revenue-per-colleague number because so much of our success has been because of our colleagues, because of the culture. All of our colleagues who work at Zoetis are incredibly purpose-driven. They love what they do. They believe what they do really matters. We invest aggressively in our culture. It has led to not just much better retention than almost any other company, but our engagement globally is 88% with our colleagues. That was last year in one of the most challenging years, and we think this is absolutely critical to our success. And what does that mean to you as shareholders? I think over 500% total shareholder return since we IPO-ed is not a bad place to be if you're one of our shareholders. And we've done this by growing our revenue faster than the market every year. As you look at this thing, it can may be -- anywhere from 2% or more in any given year. And that is even more impressive given we are the market leader in the space. We've continued to do that. We've done that again by growing adjusted net income and our margin over time, continue to do that to deliver profitable growth for our investors. And as you take this and you say, what is our long-term value proposition, it's exactly what we've always committed. We're going to grow our revenue faster than the market. We're going to grow our bottom line faster than our top line. We're going to drive growth through investments, first and foremost, internally. Then we're going to leverage BD, but we'll always commit to returning excess capital to our shareholders. So I hope I leave you with the 5 takeaways I promised at the beginning of this, that the fundamentals of animal health remain incredibly strong, and they're not just over the next few years. These are enduring market trends; that Zoetis has a solid diverse, durable innovation-driven portfolio that will drive great growth across dermas, pain, multiple, multiple categories and multiple geographies; that therefore, it gives us the financial strength to continue to invest in the future and deliver those returns; and that we're strategically positioned in the most important and fastest-growing areas in animal health. And then all this will provide you, our shareholders, with a proven track record to deliver shareholder returns that will be valued for many, many years to come. So thank you very much for listening. And now I think Chris and Wetteny, hopefully, join me on the stage. We'll go to the really fun part where we get to take your questions.

Great. Great. So maybe just to kick off the Q&A, I think you touched on this in the presentation. It seems like one of the key debates around the space has been just the health of this companion market. So can you elaborate a little bit more on what gives you such confidence that the pet owner is going to kind of hold up here and be willing to keep spending through maybe more challenging economic environment going forward?

Sure. I'll let Wetteny take this because he just finished a big market study to actually answer this question. So...

Yes. So look, certainly, we've seen the resiliency in the market. And as Kristin shared in the prepared commentary here, we've seen a real increase in the proportion of our revenues that are coming from companion animal, which has proven to be even more resilient. And so we commissioned a study recently that just completed in December across our key markets, certainly in the U.S. and our top 10 markets overall. And what we've seen in other studies previously is more than underscored, which is pet owners are facing a 20% decrease in their overall budget would not change the amount they spend on their pets. So that underscores that. But as we look -- as we exit 2022 and we're operating across the world, we continue to see strength across our business, whether you look at Europe as we exit 2022 and enter into 2023, whether you look at the U.S. where we continue to see strong demand, though some of the -- some of the clinic dynamics around labor constraints is something we're continuing to monitor, et cetera. But we continue to see that strength across the markets and where we operate, which is underscoring that resiliency that we see -- that we've seen over decades, if you look at the animal health market overall, but also our innovation driving through whatever the market is.

On that topic of clinic kind of visit growth, how sensitive is Zoetis' business? I know different players in the space have different sensitivity. So I guess, as you think about an environment where maybe you do have capacity constraints, can you manage through that given that I know your products are more recurring in nature and maybe don't require?

Yes. I mean I'd say, well, the proof is that we have been more if you look at our guidance for last year at 7% to 8%, on average, [ 8% ]. I mean we have been more resilient. And part of that is we have a lot of chronic products. We have a lot of preventative products that don't require a vet visit to go on. So I think once you're on our product, you tend to be on it for a longer period of time. So I think we are more resilient. I think the other thing to focus on is the fact that a lot of our products are moving to the e-commerce on auto ship. So once you get a prescription, you're just going to continue to get that. And even if you didn't remember to bring your pet in or you were delayed because your vet practice didn't have an appointment, Chewy is more than happy to call your event and just make sure that we should continue that Simparica Trio prescription, and they do. So I would say the other thing we're more resilient on is we have really strong relationships with corporates that let us make sure that we are the primary product that we're being given through at these times. So I do think we are not -- we have lots of products that don't require a veterinary visit and can be given through other channels as well.

Right. And on some of those efficiency metrics of the clinics kind of changing their way of doing business, do you think we'll see that in '23, that we'll start to see a pivot that you can still get back to at least like flat visit growth? Or is this going to be a multiyear process to address this?

Yes. If you look at vet clinic, I mean, historically, as you looked at those trends and even more we looked at the chart I showed, if you want to download it on the website, was 2018. It generally grows about 1%. I mean that's generally the way the vet clinic visits. And we absolutely think you'll get back to that in 2023. I think what you're really starting to see is vet clinics coming up with better models. You can train vet techs a lot faster than you can get new vets out there. So what they're starting to say is, well, a better leverage model. And that's being led by corporates, who clearly see the data, clearly see the benefits and can quickly train people and bring them on board. So you think you're going to start to see that. Maybe it will be quarter-by-quarter a constant improvement. But yes, I think you're going to get back to at least as you look at -- we'll lap some of the bad comps by the second half of the year, I think you'll be back on that chart. I don't know, Wetteny, if you...

Yes. I think if you look at the numbers, right, the visit numbers are still above where they were before the pandemic, right? But what's driven 5% to 6% growth across the 20-year period across the market isn't just the visit numbers. It's actually what people are willing to spend, and that number has accelerated through the pandemic. It was already growing and supporting that 5% to 6% because, as Kristin said, it's a 1% increase in visit numbers historically per year. But you're driving 5% to 6% growth rate, which companion animal is a bigger growth rate versus livestock in that picture. So it's really the amount they're spending per visit in the overall revenue at their clinic. That's the key driver, although visits are important as well.

So it seems like your confidence in the health of the end markets has not changed for?

There's no problem with pet owner demand, and the vet clinics will figure this other -- the short-term challenges they have out because it's in their best interest to do so. I know is when there's a demand, someone will find a way to meet it.

Absolutely. On supply chain, it seems like there's a issue we're highlighting throughout the year. It felt like it kind of came to a head in 3Q. Can you just remind us where you are in terms of addressing some of the supply chain dynamics? And should we think about that being potentially resolved getting into '23? Or are there some issues to work through still?

Yes. When we look at the most important categories where we operate in, whether you look at parasiticides, you look at our monoclonal antibodies in our derm franchise, we feel very confident entering into 2023 versus where we were in 2022, where arguably, that was the element that kept us from being able to deliver what we committed to from the beginning of the year. Now we started out the year talking about capacity constraints in 2022, for those who recall. As we got through Q2 and Q3, the impact on parasiticides a little bit more pronounced and had an impact on us on the year. We're entering 2023 in much better shape, where we essentially parasiticides don't see -- unless there's some unforeseen event out there in the world. But we're entering the year with strength in terms of our ability to deliver on demand for parasiticides. Certainly, our monoclonal antibodies are very important for us, whether you look at Librela, Solensia, Cytopoint on the derm side, where we are actually launching Librela in markets outside of Europe where we delayed those launches last year, we're doing that in 2023. So we're very confident in terms of where we're entering into with 2023 like from a supply perspective.

Great. Good to hear. On Trio, it's obviously been a phenomenal launch, about 3 years in now. Just any kind of surprises in terms of either where you've taken share from or how the -- I guess, the market for triples has evolved?

Yes. I'll start and let Wetteny build on this. We were really pleased for those of us who were with us back in 2020. We launched into the pandemic. I think it was April of 2020 was the launch days for this one. So it was -- we've been learning a lot as we went, to be honest with you. I think the first thing is that the convenience and the efficacy of the product is incredible, and it has great value. And so I think a lot of what you've seen is a faster uptake to the product than I think most people would have expected. People -- customers want to pay for innovation. They want to pay for convenience. Instead of having to take 2 products every month and remembering, one is much simpler. It's an oral. I think -- what I think many people were surprised by is how fast we've moved customers from topicals and collars into the oral category and how much customers want to pay for innovation. And we've just seen incredible strength in Trio. And I think the other thing is we were expecting competition. I mean we talk about this every time we're here. I'll answer it before you ask. We were expecting competition for the last -- but we still don't have it. We are expecting competition in the first half. We previously thought it would be very early in the year. Clearly, we haven't seen it yet. So for those in our industry, not by next week, which is VMX, which is really important for us. And we're going to make sure we seize the opportunity when that's the case. But any other insights you'd say to...

So look, if you look at small animal parasiticides, so that's companion animal excluding horses, right? So that's a $6 billion market that's growing mid- to high single digits. And we have the broadest portfolio in that segment today. And if you look at the shift from topicals and collars into oils, that's been going on for a while, and that's been expanding the market. Well, triple combination is still a relatively new standard of care, and that will continue for some time and provide some tailwind to the overall market. And we're the first mover there, which is significantly advantageous for us.