Zoetis is the world’s largest standalone manufacturer of pharmaceutical products for animals. Most of Zoetis’ competitors are the animal health units of big pharmaceutical companies. Merck and Boehringer Ingelheim both have animal health units and Eli Lilly just recently spun out its animal health unit, which is now called Elanco (tkr: ELAN). Zoetis itself was spun off from Pfizer in 2013. Since then, the company has built a strong global infrastructure, which gives it a substantial cost advantage, and it also boasts the broadest product portfolio. Zoetis has its own salesforce, which allows it to bypass distributors and market directly to veterinarians and livestock producers. The size of the global animal pharmaceutical market is estimated to be approximately $30 billion and Zoetis has about 18% of that market, with revenues of $5.3 billion in 2017. This niche has historically been somewhat “recession-proof,” given that even during recession years, pet spending has increased.

We own Zoetis based on two main investment themes. First is the increasing “humanization of pets,” as pet owners are becoming much more willing to invest substantial resources to keep their pets healthy, and treat them when they become ill or injured. In the U.S., 68% of households have pets (about 184 million companion animals), while international pet ownership is also on the rise. Second, we believe there will be greater demand for “production animals” for food in developing countries as income rises. Zoetis’ revenues are divided equally between its U.S. and international businesses. Major product categories include anti-infectives ($1.25 billion of revenue), vaccines ($1.37 billion), parasiticides ($763 million), medicated feed additives ($475 million) and other pharmaceuticals ($1.18 billion).

We had initially looked at Zoetis four years ago. The main reason we decided not to buy the stock was concern over how increasing regulation of the use of antibiotics in livestock feed might affect revenues. Since then, the FDA has issued stricter guidance on such use and the impact on Zoetis’ revenues has been modest. In the meantime, Zoetis revenues overall have continued to grow, with a smaller percentage coming from antibiotics in feed. Management has successfully introduced new products to replace these lost revenues, including important new vaccines, parasiticides and medication to treat allergies in companion animals.

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