Zoetis Inc. (ZTS) Earnings Call Transcript & Summary

Okay, guys. Let's get started. Jon Block with Stifel, and plowing forward and sticking with Animal Health. And next up, I'm happy to introduce Zoetis, the world's #1 animal health company. And today from Zoetis, we have Wetteny Joseph, Executive Vice President and Chief Financial Officer. Thanks for joining us. Really appreciate it.

I'm going to change things up and it's funny, just coming off the Analyst Day. I've gotten a bunch of questions about, "Hey, look, the stock had a really good roll on year-to-date, but it really has been -- I don't want to say straight down since the Analyst Day, but sold off. And I've gotten questions why, what's going on? Wetteny, any confusion that you want to clear up? And maybe I'll sort of ask a little bit of a leading question. One of the topics that keeps getting brought up with me is you guys talked about mid- to high single-digit revenue growth, which some people could think of as 4% to 9%, yet you talked about a market growing 4% to 6% and Zoetis continuing to grow at a premium to market. So any -- maybe a tighter band or any things that you can clarify on that, call it, revenue LRP that you provided?

Look, Jon, I won't, as usual, comment on the stock price per se, what we tried to do with the Investor Day was to step back and really share with everyone the reasons we're very optimistic about the future, what we're working on, what our capabilities are, and what drives the most productive R&D engine in animal health and where we believe that's going to continue, including new areas, product categories that we're pursuing to continue to drive our performance from an innovation perspective. So we're very pleased with that. I think the range that you gave, we were careful not to get too precise on this, but I think that sounds too wide to me, quite frankly, though I won't peg it to an exact number. The way I look at it, the industry has grown about 5% historically, put it in the range of 4% to 6%. We believe based on the underlying secular trends that we see around demographics, standard of care, population growth, et cetera, the market is expected to continue to grow in that range of 4% to 6%. And over a decade, we have performed anywhere from 2 points to 6 points above that -- on average, about 3. And so if you look at it that way, then you say, well, 4% to 6% and you do 2% to 6% on top of that, you've got a range that I think might be tighter than what I heard you just say a moment ago. And I think over time, we're looking at long -- relatively long horizon of 3 to 5 years in terms of what we wanted to focus the discussion on. And again, share our enthusiasm about our pipeline, our innovation engine, our colleagues around the world that are working tirelessly with our customers and the combination of R&D, commercial and manufacturing that has translated to the financial performance that you've seen from Zoetis over the years and that we expect to continue to drive us going forward.

Okay. That's very helpful. Maybe I'll try to ask one more sort of follow-up clarification then I can get into some more specific questions. But when we think about that 300 basis point premium to market that you grew over the past decade, from an investor standpoint, should we be thinking that has to compress. I mean, I think about that 300 bp premium and in there was creating a $1.4 billion atopic derm being the first out with Simparica Trio. So you're going to have competition come into those markets, but on the flip side, you've got pain mAbs, which you've clearly said is $1 billion plus. So help us square, does 3% have to compress? Or could it actually remain in and around that level due to some new markets that you have that are first [indiscernible] of taking off?

Yes. Look, I think if you look backwards, it's average 3%, right, a market that's grown about 5%, where we've grown 8% on a CAGR, but it's gone anywhere from 2% to 6%. And so I don't see a reason why the average of 3% would necessarily compress. I think what we're doing from an innovation perspective continues to be very robust in areas that are the greatest unmet needs in animal health. I think our portfolio is already very broad and diversified. I think OA pain is an area that we said at the Investor Day, we expect to be $1 billion plus in the 3- to 5-year horizon, by the way, which is how we define peak sales is inside of that period. Obviously, the market -- that market will continue to grow, and we'll continue to innovate in that OA pain as well. And even in the areas where we are expecting competition, we have been expecting competition in these areas for years. I mean we've been in derm for a long time. Our Apoquel product has been out for a decade. Cytopoint has been around for about 7 years. And so we've been investing in mAbs as a platform, which is allowing us to be able to go after a number of different targets through that platform and investing behind in terms of building the capacity and the scale to capitalize on those as we go forward. And in the markets that we've been in, whether it's derm or parasiticides, we continue to see room to expand those markets and continue to grow in those markets. In parasiticides, we're playing in the faster-growing end of the market, which is their [ holes ] and the triple combinations. Though that market grows around 5% to 6%, we've been playing in an area that grows faster than that. So I think given that we're playing in the areas that others in our space are playing in as well, whether it's vaccines or parasiticides and have been gaining share, by the way, meaningfully in parasiticides. We continue to have opportunity to continue to expand in derm and are also launching the next generation of the products that we have in derm. And we're going into a phase of growth coming from osteoarthritis pain as our next $1 billion franchise and shared a few areas of interest that we're working on. I think our edge on the market as we see it is sustainable.

Okay. That's great. And we're going to enter a lot of those topics, atopic derm and triple and others. I'm going to start off a little bit more granular. Destocking was clearly a big topic in the first quarter of 2023. You commented on the call that destocking seemed to conclude. I think you said around April. But since that time, another major animal health player called out destocking headwind. So I just did want to check in, has that destocking phenomenon resurfaced for you guys at all? Or do you feel comfortable that it's really in the rearview mirror?

Look, the comments we made with our first quarter call in early May continue to stand for us in terms of how we see the market. We came into the year and expected to see a low level destocking in the first quarter, which we saw. There was meaningful destocking in Q1, which we talked about on the call. We saw that continue into April, probably to the third week of April, give or take. And then we saw that stabilize. And we shared that we expect it to remain stable from here on out. We didn't factor in sort of a rebound of inventory stocking as we look ahead. But we felt that the level we got to, which was below the sort of normal range that we've seen over the years is something that would sustain and any lower than that would start to introduce challenges for distributors in terms of service levels to customers and the handling would get to the point where it could increase their costs as well. So we've continued to see the sort of activities in the market be more reflective of the end market demands for us. And as we said on the call, we expect to see more normalized growth starting in the second quarter. And by the way, that's with the destocking effects that we saw in April, which obviously are part of this.

Take that into account.

We take that into account and we say, "Hey, look, you're going to see a normalization here as we go through the rest of the year." And here, we're sitting on actually the last day of the quarter for international market, which are a month in [indiscernible] I'm expecting a very strong quarter there as we get through. And I'm expecting the mix to be more joined by companion animal as well, again, consistent with what we said from the start and what we said on the last call. I expect international to grow a bit faster than the U.S. but the growth across both to be more driven by companion animal than livestock.

Was that specific to this quarter, Wetteny? [indiscernible]?

Yes, yes. And so -- but again, all translating to what I call normalized growth as we look at the second quarter and beyond. One last thing, and I'll let you ask the next question, is that if you look at -- back in February when we gave our guidance, we said we expect the cadence across the year to be impacted by the timing of supply recovery in 2022. And I think that -- I said that's going to drive variability throughout 2023. We saw that in Q1. We're going to continue to see that in some aspects of the business. For example, for livestock, in the third quarter last year, we saw intermittent supply challenges recover a bit in the third quarter last year. We'll be up against that on livestock. But for the rest of the business for companion animal, the third quarter was a bit more challenging from a supply standpoint, so it becomes a positive comp. So not to get too much detail on specifics here, but I do think that availability will continue, but it will all translate into more normalized growth for us.

So maybe just to try to follow up on that last point. You reiterated on the first quarter call, the 6% to 8% operational revenue with guidance for the year, you've got an easy 3Q comp, a more difficult 4Q comp. So do we think about if we were to go ahead and sort of 2-year stack at more consistent. So in other words, take the year-over-year comps into effect but on a 2-year, it's somewhat consistent for the duration of the year?

Yes, I would say that's about -- that's roughly right.

Okay. Okay. Fair enough. I want to try to deconstruct 2023 growth because I've gotten questions on how it breaks down. So again, operational revenue growth guidance of 6% to 8%. I think you guys have been very clear that farm animal or livestock, pardon me, is going to be around 0, give or take, largely breakeven, that might benefit a little bit from the Jurox acquisition. And so it implies 10% to 11% growth-ish for companion animal. You've talked about atopic derm being maybe around 10%. My main question is how Trio looks? And do we think about Trio, which had a rough first quarter because of some of the destocking, is that a premium to overall [ contained ] animal growth? So again, the implied for companion animals 10% to 11%, is Trio a 13% to 15% growth or a premium to call it overall CA?

Look, I think, first of all, very consistent in how we see the year from where we started in February giving guidance on the year. At the time, we said, look, livestock is going to be minus 1% to plus 1%. We've moved from that to say it's going to be flat to plus 1%. We've moved about 1 point. And so that hasn't changed, which translates to companion animal not changing significantly. I try not to get into too much detail on a specific product. But as we said, coming out of Q1, derm is one where if you pro forma some of the noise in the quarter, you were seeing double-digit growth in derm. So we're expecting derm to operate in the low double-digit range as we see the balance of the year. And look, I would look at derm combined, both Apoquel and Cytopoint, because I do think there's some dynamics there with respect to being able to lift some of the restrictions that we had with respect to inputs for mAbs that we can capitalize on the demand that we see, both from vets and pet owners given the compliance and being able to do one injection, et cetera. So that is going to continue to drive the dynamic for us as we look ahead. I think parasiticides is an area that we have a very broad portfolio. Obviously, Trio being a big driver for us, a big product of us and saw that impacted by some of the destocking you saw in the quarter as well as through April. But as we look at the year, we're expecting strong growth coming from our Trio products as well as the rest of our parasiticides.

Okay. I'm going to try to ask it a different way just because I don't think I said a very clear question. So -- and you can get inside my head and try to walk me off the ledge, this is what I'm struggling with. If Trio were not to grow at a premium to companion animal. Let's just say, "Hey, Trio's an 8% grower. I think the incoming that I get from investors as it implies very healthy growth for what people call the legacy companion animal business, right, or the base business." If Trio is a 13%, 14% grower, considering the 1Q it had, it implies a really big high-teen 2Q to 4Q or even higher once you normalize for 4Q. So which way do you lean, do you sort of say, "Jon, it doesn't have to grow north of companion animal and therefore, the underlying base business might be healthier than you could appreciate?" Or is it, "look, 1Q was particularly ugly for Trio because of destocking, but we still think this can be a 13%, 14% grower for full year?"

Yes. Look, I'm not going to lock into a specific growth range for Trio. What I would say is if you look across the portfolio, we see strength across the board. I think you've seen some dynamics both with respect to destocking that impacted Trio as I said in Q1, as well as through April. You also see some promotional activities that impacted this market. But what we said in the first quarter was we saw an uptick in terms of our share gain in terms of patients. And so I would look at the underlying market as we go through the year. In terms of what's happening there, we still don't see a competitor yet. We expect it sometime this year. We'll see what the timing is and what their behavior is in the shorter term.

Your thoughts are [indiscernible] 2H there now.

Right. Yes. Look, we expect an approval sometime in the summer potentially be launched in the third quarter. So we'll look at what that does in terms of promotional activities that might have some short-term impacts on price or what have you, depending on what they do, we'll watch that. We don't think this is going to be a price play long term. This is more of a who -- how do we continue to transition from topicals and collars into orals and triple combinations, and we think that our first-mover advantage will play out well for us, and we're well positioned from a price standpoint. So I would look at what's the patient share? Are there more [indiscernible] patients coming in? And are we keeping up with our share or gaining share in that regard and then let the rest flow through. But I think the rest of our portfolio really holds up well here across our markets. And you don't have to have the type of growth that you saw in Trio last year, which we were not expecting any way to deliver our guidance, we've factored in our expectations around competition into the guidance that we reaffirmed as well on the first quarter call.

Okay. Fair enough. You guys, obviously, I probably should have kicked this off this way, but if you have any questions, let me know, throw your hand up, and I'll call you out. Farm animal. So I do want to touch on Farm animal, which now because of the great growth in companion animal is down to roughly 1/3 of revenue. But the snapback in livestock in 1Q '23, it was surprising the most. I know it was a little bit surprising to me. You guys described it as sort of refilling inventory levels that were a little bit low. Here we are a couple of months later. Your conviction that livestock inventory, let's call it, normalized properly and not high exiting 1Q '23?

Yes. I would put it within the normal range is what I would say. And look, there's always some level of variability. I don't want to get too precise as if it's always one number. It does vary a bit. I think you've got some different seasons within livestock with the third quarter and the fourth quarter in terms of movement of animals in the U.S. that impacts cattle business. So I don't want too -- again, too precise on one number. I think it can vary from time to time. As we exited the first quarter versus where we were in the fourth quarter, we might have been a little bit low in the fourth quarter here, but we're all within a range here as we exit the first quarter. I do expect more of a variability just in the comps, given what I said earlier, so I'll just repeat the one point, which is variability in terms of timing of stocking and timing of supply constraints in 2022, will have an impact overall, in particular for livestock. Again, the third quarter is one that I'm expecting a tougher comp for livestock given some supply recovery in the third quarter last year from a vaccine standpoint, and that will play out as well. But our expectations haven't changed here wholly, if you look at where we came into the year expecting livestock to be versus where we expect it to be now for the balance of the year, despite a 12% operational growth in the first quarter.

Yes. Got it. Okay. Fair enough. And if you can just talk to us a little bit about DRAXXIN, right? I mean we know it's been this multiyear headwind. Where are we in '23? Is this sort of through the thick of it? And then the headwind sort of fully abates exiting '23? And we can think about maybe livestock getting back to a growth profile in '24 once that headwind is behind us?

Yes. Look, I look at livestock first, and then I'll double click on DRAXXIN to fully answer your question, Jon. Look, Livestock has grown somewhere in the 2% to 4% range even if you look at backwards. And over the last couple of years, we have had this DRAXXIN headwind as well as Zoamix, a couple of products where you see some generic competition has impacted us specifically with respect to our livestock. In the first year, we saw about a 16% headwind to DRAXXIN. We started out in the mid-300s in terms of revenue, so the biggest livestock product for us globally. And we saw another -- almost 25% impact on the second year. So you get into a level now where I just won't move the needle as much. I'm not saying that we won't see more headwinds coming in, but we've also seen some volume increases that offset some of that as the price points have gotten to a point where you use this class of products a little bit more in that regard. So that is offsetting some of that. And so we expect some of that dynamic to continue to play out. But we're at a level now after 2 years of generic competition that it just won't move the overall livestock picture as much as it has the last 2 years.