Zoetis Inc. (ZTS) Earnings Call Transcript & Summary

I see the timer just starting, so I guess that's our time. Wetteny Joseph, the CFO of Zoetis is joining me here today. I'm David Westenberg, the animal health analyst here.

So you've been the top innovator in the space. You have basically entire derm market or next-generation derm product market, entirety of mAb and pain. And if your growth rate sustains, probably you could be the top in parasiticides. Now I know I'm buttering you up, but the reality is, is that it's really hard to stay on top when you're on top. So how do you sustain above-market growth with being the market in such dominant categories?

Look, I -- first of all, it's great to be here with you, Dave, at the conference. I do -- I like how you started the question, certainly. And look, I think there are a few very strong secular trends that help the industry. But because of our position in the industry and the broad portfolio that we have currently, it actually positions us to outpace the industry even before I start to think about these major franchises and innovation to come. We're already positioned to grow faster than the industry. So let me sort of unpack that a little bit, and then we'll go into some of these other areas that you just mentioned. First of all, if you look at the trends with companion animal and the human animal bond, you have a generational shift where people are placing a higher importance on the health of their pets. And as that generation continues to be a bigger proportion of the pet owners, you're actually seeing greater spend on addressing those, particularly those chronic conditions and therapeutics that we address. And because our share on companion animal is higher than others in our space, 2/3 of the company is companion animal. In the U.S., it's even higher than that as a percentage of the company. That positions us to actually grow faster. Just from that tailwind, we're better positioned to take advantage of that tailwind than others. And that's sort of the starting point, if you will, the baseline. And then on top of that, we have these major franchises that even in derm that's been around for over a decade, we continue to see significant room to continue to expand that. And then triple combinations with Trio, you mentioned as well in the question, is another category, that end of the market is growing much faster than the overall animal health and faster than the parasiticides category itself. And as a first mover in both of those cases, we continue to be positioned to capitalize on the expansion of those markets in addition to that. So I do believe we're well positioned to continue this track record of growing faster than the industry, even we are already the biggest in the space.

Got you. So you had a great year in derm and parasiticides. Now 2023 did have some interesting price and stocking dynamics. So anything we can take into next year that we should be happy about? And maybe some examples would be market positions or any learning from DTC advertising strategy that can help benefit you next year from that?

Look, we've been in a position to take price across our business historically and continue to be. I think these two specific areas, given the innovation that we brought to the market and the expansion of those, we're seeing a year where we see robust growth, both in price and volume. And so in both of those cases, by the way, volume growth outpaces price growth for both derm and for Trio, to use your example. So that gives us a lot of confidence that we can continue to take price and drive volume. Even as we are in the current year, overall in the aggregate, our price levels are higher than we expect to sustain long term. And we've talked about that historically, but we see room to grow at least, if not higher, than the historical 2% to 3%. And so I do think there's room to continue to drive growth overall and to drive volume and price growth across that spectrum.

Got you. And as we move into 2025, you had Librela, I think, launched at the end of '23. Maybe some destocking dynamics in Q1. You've had chewables. As we move into next year, any unusual comps to think about or stocking comps to think about as we move into 2025?

There's not really much to speak of, so let me sort of unpack that for you. You mentioned last year, in the first quarter, we did see some destocking across distributors, particularly in the U.S. that was fairly impactful on the business. So as we lap those in the current year and the first quarter, that contributed to the growth, although even if you exclude that, you saw robust growth from the business through the first 3 quarters. There's not really any meaningful stocking considerations other than the fourth quarter that we're in now that I'll remind everyone, we had two launches last year in the fourth quarter, right? One has been much more talked about, which is Librela, where we launched that in October last year. The one that's not talked about as much is Apoquel Chewable was launched at the same time in the U.S. And so those do have some stocking dynamics that we factor into the guidance that we just raised for the third time recently here and implying that element in that, in terms of the growth rates that we're expecting in the fourth quarter. Outside of that, there's not much of any stocking dynamics to speak of. And one last point I'll make is if you look at distribution in the U.S. and inventory levels, they have remained closer to the low end of the range that we have expected or experienced, I should say, historically. So in a year that is shaping up, the last guidance range is 10% to 11%. Other than 2021, this will be the highest top line growth year for the company, and you're talking about little to no inventory impact on that because that's remained at the low end for us.

Got you. So going back to the derm franchise and the defensibility of that, if we're ranking the different factors, you mentioned 30% is now chewable. The length of time in the market, you've been in there for 11 years and then the complementary with the portfolio, obviously, you have ability to do exclusive relationships because you have the entirety of the portfolio. Though what do you think is the actual -- if you were to rank those and which ones should keep Apoquel continue to grow, what would you pick first, second, third, et cetera? And then just in general, like there is a new entrant that is going to use price. And do you think that's going to be effective or the advantages that you have will be effective against maybe a price strategy?

Look, the first thing I would say is I like all of those, but maybe I can unpack it for you a little bit. Before we get to defense, I actually -- we get very excited about the offense and the opportunity to continue to really expand a market we've been in for over a decade. I mean, you're continuing to see double-digit growth in a product category we've been growing for 11 years. And I think if you look at what we've sized up for everyone recently, there are about 20 million dogs that are either undertreated because they're on steroids or they're not treated at all across the world with 11 million of those in the U.S., right, if you look at that combination. And so we continue to see opportunity to educate pet owners and drive the expansion of that market. And then the point I made earlier around the demographic shift in more owners having a much higher expectation of the health of their pets, that's also helping them to actually want to treat these types of things more so, right? And so that combination is helping us to continue to expand the market we've been in for a decade. So then if you then go and pivot to defense after a very exciting opportunity we see to continue to grow here on the offensive side is that we have 3 products, right? You have Apoquel film coated. Cytopoint has been around for 7, 8 years, continue to see growth and demand for Cytopoint outpace overall here, which we think there's more room to continue to drive that. And then as I mentioned earlier, we launched Apoquel chewable in the U.S. a year ago, October. It's been in the international markets a little bit longer. And you're seeing an increase in the conversion of Apoquel orders from the film coated tablet over to the chewable, which positions us well in terms of preparing for competition. So I believe we're well positioned outside the U.S. In Europe, we're north of 50% now chewable versus film coated. And we're -- we exited Q3 about 30% in the U.S. within one year, which is a much faster rate than we did outside the U.S. So we're very pleased with that conversion profile. And this is all before we talk about new innovation and other things that we're working on in this category that we own. So I think the pie is going to grow before we start to talk about sharing it with anyone else, and we're well positioned to be able to capitalize on the expansion of that market given the portfolio that we have. Not to mention 11 years and tens of millions of dogs that have been treated on robotics with a safety profile that's phenomenal and a satisfaction level that's phenomenal. So before we start to think about what price positioning might look like from competition, the question is, are they presenting a differentiated product on the positive side and -- or not? And if they're not, then I think we're very pleased with how we're positioned.

Got it. Sticking with the theme of price, and I'm going to go -- this is my own math. So if I screw this up, it's my fault. I think CPI has been -- or veterinary CPI has definitely been up more than general CPI. But I think groceries, I think it's been 28% since pre-pandemic, but veterinary care is up over 40%. As we look at these best-selling drugs, I mean, they're premium products, they deserve to get the price increases. But how are you -- how confident are you in terms of the consumer continuing to take price across veterinary care?

I think I've mentioned in this conversation the fact that we've seen volume outpace price even with us taking higher prices this year than we have historically. I think that gives us a lot of confidence as we continue to watch the market to see that there's room to continue to grow and to grow -- to have a balance between those components. So we do have confidence in being able to continue to drive both price and volume. And as I said, we've seen increased visits to the clinic, for example, for derm. So periodic visits were up over 4% this last quarter in the clinic as well as what's happening in alternative channels, which is outpacing the growth that we're seeing across the clinic here. So the elasticity we see here is strong in being able to continue to drive both and grow these franchises. So that gives us a lot of confidence going forward. I think if you look at services across the vet clinic, there's been a bit of a catch-up where we have consistently taken 2% to 3% price across our products in the aggregate. Now different price levels for different products depending on where they sit, the value we're bringing to customers, et cetera. So it varies. But overall, in the aggregate 2% to 3%. That's been a consistent level we've done. It's not just an uptick over the last 2 to 3 years. So when we're operating at 4% to 5%, it's 1 or 2 points higher than we've done. It's not 3, 4, 5 points higher than we've done. And I think that expectation in terms of customers that we're going to take 2 to 3 at least is something that's baked into how we operate, and we see the opportunity to continue to do that.

Got you. Let's move on to Librela. It was flat sequentially in the U.S. and your numbers in Q3 were really strong. So the stock took a step back there. Now in terms of concerns on Librela flat sequentially, can you give us maybe some other examples, including Librela ex U.S., where you maybe didn't see flat sequential -- or where you didn't see some type of flat sequential growth? I mean you've been in the international markets for years now. What's the seasonality look like in Librela?

Yes. Look, we've seen this before. And it's not just in Librela ex U.S. We've seen it in other major franchises that we've launched in markets over the years. You see a bit of a stair-step approach at times. And this is the reason why we don't track sequential growth as a key performance indicator for us. We haven't in the past, and we don't intend to here either. Now to be more specific, if you look at last year this time in the third quarter, the question on the earnings call was why did we not see sequential growth in Librela in Europe? That was the exact question. A year later, it's why are we not seeing sequential growth in Librela in the U.S. So this is not unusual, uncommon for us as we build new markets with new modalities, et cetera. It's happened even with Trio and Cytopoint, if you look across, you'll see this phenomenon. So we see ourselves here at a time where there's significant opportunity to grow this. We're still in the early innings. 123% growth in the quarter, by the way, we're very pleased with. This has been the most successful launch we've ever had as a company and quite frankly, in the industry. And where we are today is substantial more room to grow outside the U.S. You've seen really robust growth even 4 years out. We continue to expect strong growth year-over-year as we look ahead. And in the U.S., we're just one year in. And just to put it in context for you, there are about 27 million, so 40% prevalence on OA, right? 27 million dogs, I would say, from a Librela standpoint, obviously, Solensia, by the way, is also doing really well. Somewhere in the neighborhood of 40%, 50% growth we continue to see year-on-year year-over-year quarterly on Solensia, which we're pleased with. But going back to Librela, $27 million is sort of the market size. About 9 million are being treated today, largely with NSAIDs. We have 1.1 million of those. So the opportunity here and the long-term tailwind we expect from growth in OA pain, and I'm being very specific on the U.S., but that's -- it's true globally, is really, really phenomenal. And we remain very confident that OA pain will be our next $1 billion franchise, and we're on our way. Again, sequential is not where we track it. The one thing I mentioned earlier, I'll repeat now is that recall, last year, we did have a launch in the fourth quarter for Librela in the U.S. We delivered $44 million of revenues in that quarter. Now let's dissect that for a second. What was surprising to the upside is the penetration levels of Librela out of the gates were really strong, 65% in that neighborhood. We've never had any product that we've launched that got to as many clinics as fast as Librela, not any single product that we track by a long shot. And so what that translates to is you have a lot more clinics you seeding with the product, which means more stocking in that number, which is why we said it was at least 1/3 of the sales in the quarter were actually stocking of Librela into clinics. And so that's a factor to really think about. Again, sequential is not what we track as a KPI. It hasn't been -- it won't be going forward. So as we lap that, that stocking effect is something to be mindful of in terms of Librela. And as I said, we've seen this phenomenon where you see some flattish quarters in other products, and you've seen it outside the U.S. as well. One last point on Librela, I think, is important is where are we on the evolution in the U.S. versus where we are outside the U.S. We are now about 2/3 moderate to mild cases in Europe. And we're seeing that really increase the months on therapy. So in any given year, how many months are the patients on the product. And that's gone from 2 or so, 2.5 years ago, 4 to 5 months, and then went to 6 or 7 months, now it's 7 to 8 months. So that's a really meaningful increase in how many months on therapy. The U.S. is not as far along in terms of moderate because we're only a year in versus 4. And what that means is severe cases are going to have a bit more churn, more turnover of the patient base. As a result, which creates some of this phenomenon that I just described as well, which you don't see as much now in Europe at more moderate cases.

Got it. You actually -- long answer, and you actually answered the next 2, so it's okay.

That's good. I was being a little bit more efficient, I guess.

And then -- yes, no one wants to hear me talk. Just in terms of concerns on the label change, I mean, do you have a time estimate when a label change might occur? And is there any concern here? I know the neurological lens label on the isoxazoline class, but you still see a major shift to isoxazolines. Any impact from any kind of label change?

Yes. Look, one thing I would say is we remain very confident that any label change that we would see in the U.S. would look like other label changes we've seen outside the U.S. So unpacking that without giving a extended answer, I would say, is label changes is a commonplace in our space, both in animal health and certainly in human health as well after product launches in the first 1 to 3 years, let's say, there are post-marketing observations that are done and labels are updated to reflect what's being observed out in clinic. And so we've had label changes outside the U.S. We've had them in Europe, in the U.K., in Canada, Switzerland. And these are markets that continue to grow really nicely for us. We talked about already the strong growth we're seeing outside the U.S. even after label updates. So while I won't give a specific time frame because it's not completely within our control as we work with the agency. We continue to have very active and good conversations that give us confidence that any label change is going to look like those that we've seen in other markets.

Got you. So next one is a little aggressive, so I'll start off with a little bit of softness here. When I picked up coverage a long time ago, I think you were 40% companion animal, 60% production animal. And I think it's shifted like something like 65% companion animal these days, which means great innovation across animal -- companion animal. Now maybe really -- I mean, in terms of production animal, I don't believe you had any new blockbusters. So do you anticipate building any new categories in Farm Animal? Or is this purely a kind of a product extension kind of market? And give a little credit to your competitor, Elanco is using some of this environmental sustainability as like a new category. I mean, is there any new categories outside of maybe that?

Yes. Look, the first thing I would say is, yes, you have seen a significant shift over the last decade where the company went from 2/3 production animal to now 2/3 companion animal. And briefly on that side is it's a combination, right? It's a compounding effect of a demographic shift in terms of how people see their pets and how they want to treat them from a human-animal bond perspective that drives a big part of that. And then innovation on top of it, which we have led in our industry and continue to be in position to lead that's adding to that. So two things that are doing, not just the innovation. The second part of your question really around production animal is that while we don't tend to talk about every update and every approval, we have approvals all the time across markets. We have geo expansions, we have life cycle innovations and so on that really continue to drive growth for us on both sides of the business in terms of livestock and companion animal. So livestock is an area that we continue to expect the industry to grow between 2% to 4%. This year, it's growing faster than that, and we're growing faster than that this year as well. But this is an industry we put in that 2% to 4% range. And the secular trend there is keeping animals healthy to your point around sustainability. The most sustainable animals are the ones who are healthy, which means preventing them from getting sick to begin with, which means they're more productive. The feed that they consume to be productive is less, relatively speaking, if they're healthier, and that drives the business. And so we're focused on vaccines and genetics work that we do and alternatives to antibiotics and so on to keep those animals healthy on top of a secular trend, which is population growth over the next 25 to 30 years, which will be 2 billion more people who are going to be needing to consume more protein and more animal protein in particular, which drives long-term tailwind for this industry. So we're well positioned here as well. We do have lots of innovation and launches that happen here. They just don't tend to be the same size. You don't have the chronic conditions because these animals don't live as long to develop those chronic conditions that you see in companion animal.

Got you. Well, speaking of innovation here, in your Investor Day in 2023, you discussed oncology, chronic kidney disease, cardiovascular health, half-life extension technology. I don't think since then, you've discussed any of those new products for a while. So in 2025, do we get any pipeline updates? I'm not asking for specifics, but I'm asking for -- are we going to get in anticipation of...

Well, I'll give you some color here. It won't be unveiling new data in terms of what we expect specific for 2025. We remain very, very pleased with the progression of our pipeline across the board and excited about those areas as well as excitement around continued durability and growth from our existing franchises where there's significant more room for those to expand. We talked derm earlier. I didn't talk about Trio and parasiticides as much, but that also presents quite an attractive space given triple combinations are growing substantially above animal health and above parasiticides categorically. So we're very happy with what we're seeing across the portfolio. Our existing portfolio continue to expand. OA pain is still in the early stages here as well, but then on the new areas, chronic kidney disease, oncology, cardiology, those are very exciting areas that we continue to pursue across our pipeline that will drive growth. And we see life cycle innovation as well, we highlighted during Investor Day as being meaningful to incremental growth across existing franchises for us.

Got you. Now I think you started a pretty large repurchase program. Is that the favorite capital deployment strategy right now? Or is dividends a higher priority?

No, those are not our top 2 priorities, actually. If you look at what we've done historically and where our focus is, it's on investing internally in the business to drive organic growth. And certainly, if you look at the investments we've been making in R&D, we just talked about the pipeline, so I won't regurgitate any of that. On top of investments we're making in our manufacturing and supply chain areas, digital, technology, et cetera, those are areas that will drive our growth long term that we're very excited about. Before we get to M&A, other partnerships that we do, while M&A tends to be more tuck-in type size deals as well as some of the R&D type deals, which we get very excited about, what they do to us -- for us in terms of our pipeline, giving us additional methods to target unmet needs and so on. So we're excited about those as well before you get to dividends and share buybacks. And I think what you've seen from us is about a 20% CAGR on the dividend over the last 10 years. We tend to grow that at or slightly above our adjusted net income rate. That continues to be the case. And we like the flexibility of leveraging share buybacks. And when we stare at an intrinsic value based on our confidence in looking at the mid- to long term, what we're going to be able to continue to grow from the underlying market on top of our innovation, it gives us confidence to then be in a position to buy our shares when we see them where they are. So that's what's behind what you're seeing, not a shift in thinking or prioritization. And we're generating significant cash flows where we don't have to make a choice. We can actually invest in the business and grow the dividend and do share buybacks as well.

Got you. 10 seconds left. You came in, what, 2, 3 years ago?

Yes, just over 3 years.

Three years ago. What has surprised you the most on the positive side?

I think it's the combination that I think is maybe underappreciated of -- we talk about innovation a lot, which continues to be a really strength of ours, the productivity of what we get out of our R&D. And -- but the combination of that and our commercial excellence, how we grow markets, how you can still see double-digit growth in dermatology 11 years later is really, really impactful. And the third leg of the stool, I like to call it, is what we do in terms of scaling innovation to be able to drive a price that customers will pay for innovation. I think the combination of the three is what makes Zoetis, Zoetis. And that is something that I didn't appreciate enough coming in and certainly over the last 3.5 years have come to really appreciate a lot.

Thank you.