Zoetis Can Save Man’s Best Friend

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Business Description

Company: Zoetis Inc. is a global leader in the discovery, development, manufacture and commercialization of animal health medicines and vaccines, with a focus on both livestock and companion animals. We have a diversified business, commercializing products across eight core species: cattle, swine, poultry, sheep and fish (collectively, livestock) and dogs, cats and horses (collectively, companion animals); and within five major product categories: anti-infective, vaccines, parasiticides, medicated feed additives and other pharmaceuticals.

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Investment Rational

Zoetis Inc. is being recommended as a Buy for the following reasons.

Growth of pet ownership and concern of animal welfare: Many types of pets have long been considered part of the family, but in recent years that has started to translate to actually treating pets more like people – a trend called “humanization.” Pet owners are seeking out higher quality foods, more high-end accessories and more expensive medical treatments. It increasing their willingness to spend on pet healthcare. Pets (like people) are living longer, requiring more complex and extended medical care. Businesses that cater to these niche products and services are booming. Baby boomers are launching their real kids into the wild and replacing them with pets – and they are pampering them. In almost all spending categories, spending declines once a person reaches 55 years of age – but pet spending is peaking between the ages of 55 and 64. In other end, millennials – people born between 1985-2010 – are probably the first generation to grow up thinking of pets more like humans than animals. They are finding their independence and have disposable income – and they are buying pets and spoiling them. Great for the industry – these folks will be loyal customers for decades.

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Growth of emerging market for meat consumption: 72% of Zoetis Inc.’s international revenue is come from livestock. There is a positive correlation between income level and meat consumption. Improving standards of living in the emerging markets should drive greater adoption of meat-heavy diets over the longer term. To meet the demand, the world’s livestock sector is growing at an unprecedented rate. Demand for livestock products will nearly double in sub-Saharan Africa and South Asia, from 200 kilocalories per person per day in 2000 to some 400 kilocalories in 2050. People In the developing world eat 32 kilograms of meat a year on average, compared to 80 kilograms per person in the industrial world. Looking at the changes over time by country reveals that, in most countries, the per capita consumption of meat increases along with the rise in per capita real GDP. It seems likely that this relationship arises because meat is not an essential product like grains, which are used as a food staple, and its consumption is easily influenced by income level. So Zoetis expect to be benefit from growth number of livestock in emerging market globally.

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Market leader and the only one pure-play: Zoetis Inc. is the world’s biggest pure-play manufacturer of healthcare products used in animals. The company’s livestock and companion animal product lines and its global footprint means that it’s positioned to capitalize on growing demand tied to a larger and wealthier population. They are sole focus in animal products, their product portfolio enjoys the protection of approximately 4,800 granted patents and 1,700 pending patent applications, filed in more than 60 countries, with a focus on major markets, including Australia, Brazil, Canada, China, Europe, Japan and the United States, as well as other countries with strong patent systems. Many of the patents and patent applications in the portfolio are the result of their in-house research and development, while other patents and patent applications in our portfolio were wholly or partially developed by third parties and are licensed to Zoetis.

Absolute pricing power: Unlike human health industry, the medical insurance company have huge economic incentive to suppress the medicine price. In other side, medical care has been seen a human right. So the government will trying to suppress the medicine price if it’s too high. Since the animal health industry lacks concerned large payers like Medicare, governments, or large insurance companies, Zoetis maintains significant pricing power.

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Operating Segments

The animal health medicines and vaccines market is characterized by meaningful differences in customer needs across different regions. As a result of these differences, among other things, they organize and operate their business in two segments: the United States and International. United States with revenue of

$2,447 million, or 51% of total revenue for the year; and International with revenue of $2,390 million, or 49% of total revenue for the year 2016.

They directly market our products in approximately 45 countries across North America, Europe, Africa, Asia, Australia and South America, and our products are sold in more than 100 countries. Through their efforts to establish an early and direct presence in many emerging markets, such as Brazil, China and Mexico, emerging markets contributed 22% of their revenue for the year 2016.

Within each of these operating segments, they offer a diversified product portfolio for both livestock and companion animal customers so that they can capitalize on local trends and customer needs. Livestock with revenue of $2,881 million, or 58.9% of total revenue for the year; and companion animal with revenue of $1,956 million, or 40.0% of total revenue for the year 2016.

We can see in the United States, 50% of revenue come from companion animals, most came from cats and dogs. In the international, only 31% is from companion animals, most revenue came from other livestock. Especially in emerging countries, 82% of revenue comes from livestock. In the past 5 years, revenue growth mostly from companion animal: growth 28%, livestock only growth 2.7%.

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Recent successful product introductions have skewed Zoetis’s mix a little more toward companion animals (dogs, cats, and horses), but livestock still make up close to 60% of the sales mix, with cattle accounting for roughly a third of revenue. Cats and dogs collectively account for more than this (close to 40%), while the swine and poultry categories within livestock are also double-digit contributors.

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Their major product categories are : Anti-infectives: products that prevent, kill or slow the growth of bacteria, fungi or protozoa. Vaccines: biological preparations that help prevent diseases of the respiratory, gastrointestinal and reproductive tracts or induce a specific immune response. Parasiticides: products that prevent or eliminate external and internal parasites such as fleas, ticks and worms. Medicated feed additives: products added to animal feed that provide medicines to livestock.  Other pharmaceutical products: pain and sedation, oncology, antiemetic, allergy and dermatology, and reproductive products. Their remaining revenue is derived from other product categories, such as nutritionals and agribusiness, as well as products and services in complementary areas, including biodevices, diagnostics, genetics.

In 2016, their top selling product line, the ceftiofur line (Broad-spectrum cephalosporin antibiotic for cattle, sheep and swine), contributed approximately 7% of our revenue. The ceftiofur line and our next three top selling products, Revolution® (antiparasitic for protection against fleas, heartworm disease and ear mites in cats and dogs), Draxxin(Single-dose low-volume antibiotic for the treatment and prevention of bovine and respiratory disease for cattle, swine and sheep)® and Apoquel®( selective inhibitor of the Janus Kinase 1 enzyme for dog), contributed approximately 25% of our revenue. Their top ten product lines contributed 40% of our revenue.

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Competitors

Zoetis is the clear leader in the global animal health industry, holding top three share in virtually every relevant sub-market where it competes and overall market share leadership as well. Its revenue was 44% more than next big player. Zoetis is the overall leader in drugs, vaccines, and related products for cattle and swine (with over 20% share and high teens share, respectively) and the #2 provider to the poultry and companion animal markets.

Not only it’s the biggest, it’s the only pure-player in top seven biggest company. Others are just a subdivision of a pharmaceutical companies. The next three biggest player, Merek’s animal division just contribute 8.7% of its total revenue, Elanco is 14.6%, and Merial is 6.5%. In other word, if you want to invest purely in the animal health industry, Zoetis is your only and the best choice.

And we believe it possesses the widest moat of all the players. While the industry as a whole possesses many characteristics that are conducive to moats, Zoetis’ leading revenue and global infrastructure gives it a cost advantage over its peers. The animal health industry has been largely ignored because these businesses

are often buried within larger human health companies, but it has many attractive characteristics, including cash-pay buyers, a fragmented customer base, and minimal generic competition. Due to the fragmented and cash-pay customer base, animal drugmakers hold significant pricing power. Pet health insurance, while an increasingly popular product, is still relatively rare, with less than 1 percent of pet owners purchasing a policy. There is no such thing as Medicare for elderly canines and felines. Moreover, options to sue in the event of veterinary malpractice are quite limited.

Zoetis has long prided itself on a balanced model with no heavy reliance on any particular product. That said, antibiotics (or “anti-infectives”) have long been a cornerstone of the business, contributing about a quarter of revenue (down from close a third a few years ago) and representing one of the company’s strongest markets (over 40% share). Vaccines contribute about one-quarter of revenue, and anti-parasitics contribute another 15% or so. Medicated feeds make up about 10% of revenue, with the remainder going into the catch-all category of “other”.

I would expect “other” to become more significant in the coming years. Zoetis has recently launched two meaningful products for the canine atopic dermatitis market, and I would expect the company to show more interest in markets like pain/inflammation, anesthesia, nephrology, cardiology, and maybe oncology in the companion space, while also expanding its capabilities in reproductive health in the livestock market.

Using the most commonly-cited numbers for the size of the market, Zoetis has close to 20% share of the animal drug/vaccine market, with Merck (NYSE:MRK) and Lilly (NYSE:LLY) both in the low teens. With Sanofi (NYSE:SNY) recently swapping its Merial animal health business to Boerhinger Ingelheim, that business now likely has a market share around the mid-teens, though future updates will likely be sparse given that BI is a private company.

Industry Analysis

Pet industry revenue has shown growth even during times of economic trouble, including the recent Great Recession (Exhibit 6), so it only makes sense that our current relative economic strength bodes well for continued industry strength. Zoetis will benefit from pet owners’ increasingly viewing pets as members of the family, which drastically increases their willingness to pay for expensive treatments. Zoetis is likely to grow at a rate relatively close to the industry, but it should be able to maintain above-average margins due to its scale. Especially in emerging markets, Zoetis’ scale allows it to use its own salesforce, while smaller competitors are often forced to rely on more expensive distributors. Spending on animal medical needs has soared over the past two decades. According to an annual survey by the American Pet Products Association, Americans spent $15.4 billion on veterinary care in 2015. Revenue in the whole pet industry is expected to be $62.75 billion in 2016, an increase of more than 4% over 2015. The average annual growth rate since 2002 is 5.4%, and revenue has been growing steadily for well over 20 years. According to the Bureau of Labor Statistics, above average job growth is expected for the industry – 11% growth between 2014 and 2024.

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Trends Driving Pet Industry Growth

The market for companion animal healthcare is likewise attractive, but better-understood. Investors have been hearing for years about the attractiveness of the market, as people continue to spend on their pets through companies like VCA Antech, IDEXX (NASDAQ:IDXX), and so on. Zoetis has solid share here overall, and recently moved into the oral anti-parasite market with its Simparca flea and tick medication. In the coming years, I expect the company to broaden its focus in the companion animal market, as there are meaningful opportunities across the spectrum of diseases/conditions. There are a number of trends supporting strong growth in the industry and they show no signs of slowing down. For recent years, growth of total U.S. pet industry expenditures is stately around 4%.

Humanization: Many types of pets have long been considered part of the family, but in recent years that has started to translate to actually treating pets more like people – a trend called “humanization.” Pet owners are seeking out higher quality foods, more high-end accessories and more expensive medical treatments. Largely gone are the days of “outside dogs” that just “see to themselves.”


Premiumization:
Premiumization is the creation of higher end or specialty products and services to cater to these elevated requirements for our pets. Organic and natural treats and foods, high-tech medical therapies and medicines, luxury services and even spas – nothing is too good! Businesses that cater to these niche products and services are booming!

Health Benefits: Another driving force is a greater appreciation – based on scientific research – of the bond between people and their pets. According to the Human Animal Bond Research Initiative Foundation (HABRI), “People are happier and healthier in the presence of animals. Scientifically-documented benefits…include decreased blood pressure, reduced anxiety, and enhanced feelings of well-being.” Though the results are preliminary, a HABRI study has indicated a potential $11.7 billion savings to the US healthcare system that can be tied to pet ownership.

Demographics: Current US demographic trends also favor continued industry strength based on two groups: baby boomers and millennials. Baby boomers are launching their real kids into the wild and replacing them with pets – and they are pampering them. In almost all spending categories, spending declines once a person reaches 55 years of age – but pet spending is peaking between the ages of 55 and 64! Millennials – people born between 1985-2010 – are probably the first generation to grow up thinking of pets more like humans than animals. They are finding their independence and have disposable income – and they are buying pets and spoiling them. Great for the industry – these folks will be loyal customers for decades.

Zoetis enjoys a wide economic moat thanks to its intangible assets and scale. Although patents are not essential for maintaining a product in the animal health industry, 20% of the firm’s revenue comes from products protected by patents that allow Zoetis to charge a premium price and insulate it from competition.

The firm’s strong brand name is another advantage over competitors. When customers are using drugs on potentially millions of dollars’ worth of livestock, or a pet that they love like a family member, they will be willing to pay a premium to buy from a firm they trust. Scale also provides Zoetis with a key advantage. Because of the highly fragmented customer base, the salesforce, distribution, and relationships are extremely important.

Animal drug market is the relative lack of generic pressure. There are companies making generic drugs for  this market (like the UK’s Dechra (OTC:DCHPF)), but the capital requirements and small individual drug markets (remember, a “blockbuster” is $100 million) have kept generic penetration to less than a quarter of the market, and generics are often priced at only a modest (10% to 30%) discount to branded drugs.
One of the best examples of the strength of Zoetis’ moat is its pain medication for dogs, Rimadyl. The product lost patent exclusivity in 2001, but sales are currently 35% higher than they were in 2001. Vets’ relationship and trust in Zoetis have allowed Rimadyl to maintain and increase sales despite generic competition.

Trends Driving Livestock Industry Growth

Livestock remains a growth opportunity for Zoetis as people still continue to prefer to eat animal protein when they have the money to do so. The livestock market opportunity is worth upwards of $14 billion a year, growing at a mid-single-digit rate as countries like China continue to increase their meat consumption. While cattle will likely remain the biggest market for Zoetis within livestock, the company has made a

couple of acquisitions to expand into aquaculture – a fast-growing protein market currently worth about $400 million, but likely to continue to grow as wild stocks come under more and more pressure from over-fishing.

Given the growth in demand for protein consumption, again due to the rise of middle classes globally, the demand to protect these animals will only increase. This industry also benefits from favorable growth tailwinds that should allow Zoetis to increase revenue at a mid-single-digit long-term growth rate. Rising standards of living in emerging markets should lead to wider adoption of meat-heavy diets, driving greater demand for livestock products. We can see the growth rate of meat consumption is around 3% to 5% in recent years, the developed countries is -1% to 2%.
Per capita meat consumption for beef and veal, pork, and poultry has grown around 3 percent annually in developing and emerging economies (DEE) since the mid-1990s, while growth has been only about 0.4 percent for developed countries. The greatest increase in per capita meat consumption is in the Middle East and North Africa (MENA), followed by Southeast Asia and South America. For the MENA region, per capita meat consumption has doubled since the mid-1990s, from 12 to 24 kilograms (kg), mainly reflecting gains in poultry. In Southeast Asia and South America, meat consumption per capita has increased from 10 to 18 kg, and from 55 to 85 kg, respectively. In contrast, per capita meat consumption in developed countries, while higher than in the DEE, has increased by a smaller amount, from 86 to 92 kg.

To meet the growing meat and feed products demand, the DEE is projected to both increase meat production and import more feed products and meat. Producing more meat requires expansion of feed grain production, and hence, the amount of cropland would likely be expanded. If projected increases in meat production are unable to meet future demand, countries will likely either import more feed to expand meat production or import more meat products. The increased import demands for feed and meat could increase global prices.The various regions of the DEE are the main sources of projected growth for meat and feed demand, leading to projected increases in global trade for these commodities. Important factors for such growth are increasing incomes and urbanization along with an expanding middle class, implying that a greater percentage of the population can afford to consume meat and gain access to meat markets. These factors can change consumption patterns and preferences away from traditional food sources and staples toward greater diet diversification and higher quality protein from meat.

Given that two-thirds of the world’s population lives in the DEE, with its relatively faster population and income growth, potential opportunities to increase exports exist for major meat and feed producing countries such as the United States.

Industry Advantage over Human Pharma

Industry dynamics are such that they have structural advantages over traditional pharmaceutical businesses. We believe that the animal health industry is more favorable because it lacks the generics industry and infrastructure that creates an end-life for many of their drugs and vaccines. One of the primary reasons there is a lack of a generics industry in the animal health sector is the lack of infrastructure to sell to farmers and vets. Zoetis’ direct distribution model and their strong relationship with ranchers and vets creates a significant barrier to entry. The setup of this network of sales distribution alone would require significant time and resources for a generic drug that would likely have low-margin.

They also do not have to worry about third-party payers like traditional pharmaceutical companies must contend with. This is a cash pay business whether to ranchers for animal health or for pet owners to vets. This removes the large payers risks associated with traditional drug companies. In addition, they don’t have to worry about the large buyer discounts that are associated in some markets. Nor do they have to worry about third-party payers pushing a certain drug over another like in the traditional space. We believe this is a major advantage for the animal health industry.

Lastly, the R&D cycle in animal health is much shorter and much cheaper than compared with the human pharmaceutical industry. As it takes about half as long as for human drugs (around five to six years) and typically costs less than $20 million (sometimes less than $10 million). One of the key considerations for the shorter life cycle is the ability to conduct research on the targeted species right away as opposed to the human pharma R&D sector. Drugs can come to the market much faster due to this factor, along with the shorter lifespans for animals allowing for faster data churn. The market opportunities are generally more modest; a “blockbuster” in animal health is generally a drug with $100 million to $200 million in peak sales prospects.

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On the human health side, firms are traditionally at the mercy of payers. Government payers or large managed- care organizations have the power to force generic utilization, squash price increases, and even in extreme cases force price cuts onto drug manufacturers. However, animal health products are purchased by a fragmented group of meat producers, veterinarians, and pet owners, allowing very little bargaining power over the highly concentrated animal health firms. Zoetis’ broad portfolio can support its own salesforce, allowing the firm to bypass distributors. Barriers to entry are significant in both capital and time. Although not nearly as expensive or as time-consuming as in human health, it is still very challenging to bring a new animal health product to market. Given the small market size and relatively modest sales potential of products, the reward often will not justify a new competitor pursuing clinical trials to bring a product to market.

Animal medical spending appears to be increasing at a faster rate than the human equivalent. Data from the federal Consumer Expenditure Survey shows that between 1996 and 2012, our own health care spending surged by almost 50 percent while pet medical spending jumped by 60 percent. During the same period, the percentage of physicians increased by 40 percent while the supply of veterinarians all but doubled.

Long-Term Secular Story

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There are three long-term megatrends that are unlikely to be derailed even in the face of a macro slowdown and weakness in key end-markets for the firm. Population growth around the globe with rising consumer demand for meat and dairy products as diets become more ‘westernized’, in conjunction with higher pet ownership numbers increasing pet spending levels, support the business’s core products. Zoetis has a top three position in every major geography and product category demonstrating their clear leadership to take advantage of these trends.

Multiple avenues for Zoetis to do better and to grow the business. The company’s involvement in biologicals has thus far been limited, but it could be a meaningful growth opportunity in companion animals, as could expansion into other therapeutic classes like oncology. Further market expansion (like the move into aquaculture) can likewise bring in more revenue. Zoetis could also look to expand into new adjacent lines of business. Diagnostics could be a logical extension of the company’s platform, particularly in companion animals, and expanding further into animal breeding tools like genetics (in the livestock business) could likewise make sense.

The growth in population is augmented by the growing middle class and increasing urbanization of populations. The animal health business for the protein industry remains a key growth driver as these larger middle class populations consume more protein and protein-related products. Even with the economic slowdown that has been realized in many of their core ’emerging’ countries, these factors are unlikely to affect the industry in the same way they affect other market sectors.

Despite the slowdown in China, we expect China will remain a strong growth story for the firm as the animal health industry becomes essential for feeding their population. With an expectation for continued strong growth, the way that China will produce animal proteins will change and become more favorable for the animal health industry. It will be driven by consolidation of this production, from small farms to more industrial livestock operations like exists in the US. This consolidation will drive sales and require a need for product innovation and more sophistication.

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The emerging markets are rapidly closing the gap in meat and dairy consumption on a per capita basis. Over the next two or three decades, that gap is expected to close as these developing nations become wealthier and their middle classes grow rapidly. Even developed markets are expected to experience growth, which we think adds to the secular growth theme. In other words, this is not an industry where the developed world is declining and the developing growing. We believe Zoetis should expect a mid-single digit organic growth industry trend for the next decade or more providing a solid backdrop for growth.

Risk

Generics have not historically been a major factor, which could change in the future. What’s more, it seems like the elevated level of market interest in the sector over the last decade has led to more start-ups in the space. While more competitive pressure is a potential risk factor for Zoetis, in practice, an increase in the number of start-ups may actually become an opportunity for future M&A, as the company’s size makes large-scale M&A impractical now.

Changes to food production policies is another threat to consider. There is a cottage industry in trying to make people afraid of their food, and that has led to companies and consumers pushing back on things like the use of antibiotics in livestock. The medicated feed business is probably the most vulnerable segment (an area where Phibro (NASDAQ:PAHC) also competes), but greater pressure against the use of antibiotics is at least a plausible risk factor.

Last and not least is a non-quantitative issue – Zoetis seems to get batted around relatively frequently on the basis of its quarterly earnings, even though management has gone to some length to forewarn the Street that quarterly results can be volatile and not indicative of emerging trends. Nevertheless, there’s a sizable institutional presence here, so it’s likely not going to change.

Financial Analysis 

The company controls roughly 20% of the animal health market with a strong scale advantages and pipeline with over two-thirds of those less than four years away from commercialization. This kind of scale was loosely integrated into the larger Pfizer business. When the company went public the assets associated with Zoetis were highly fragmented with over 30 sites as well as other arrangements with their former parent company.

We believe that now that they are a standalone company, there is a large opportunity to consolidate their manufacturing network and increase efficiency. In the first quarter of last year, management announced an efficiency initiative to consolidate and simplify some of their operations, but we feel this is just the start. In the three years since going public, they have increased their EBITDA margins from 25% to 33%, without much additional in terms of operational cost improvement programs.

The new cost-savings program is targeting a massive $300 million in savings by 2017, which is over 6.3% of revenue. This should take the 28% current EBIT margin to over 35% by the end of 2017. By taking out many non-profitable and less productive products and completing the build-out of their direct sales force which should limit operating expense growth while growing sales, margins are set to inflect. We like the alignment of management incentives whom only get paid if the cost savings are in excess of $300 million. To us, this means that the $300 million is the lower bound of what they expect to save under their current plan. At $300 million, EBITDA margins would be just over 34% on an adjusted basis. Thus, we think the 34% is lower-risk, lower-bound target for the company and that 35% to 38% is more likely.

Industry dynamics are also a factor as cheaper feed costs for livestock and higher meat prices should increase profitability to ranchers. Like engineered seeds or potash to the agricultural industry, higher profitability to the livestock industry means greater sales for the animal health industry. Herd liquidation over the last couple of years along with disease outbreaks restricted supply in 2014 and 2015. Those disease outbreaks are providing a solid demand environment today as ranchers move to protect their herds.

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In 2015, the company acquired Pharmaq for $765 million from a third-party institutional fund. The deal would expand the company into the fish and aquaculture vaccine market, which helps protect salmon from sea lice. This is a faster-growing market than the livestock industry. Fish is the most consumed animal product in the world, and 50% of this consumption comes from farmed fish. With the addition of fish to their portfolio, they now have all the relevant species under their umbrella.

The balance sheet is under-levered in our opinion given the recurring revenue and the defensive nature of the business. This leverage is well within their comfort range giving them a lot of flexibility to do additional bolt-on acquisitions. We think the balance sheet could be expanded to 4x net debt-to-EBITDA which is more in line with their competitors. The company has an additional $1.1 billion in excess revolver capacity which would eliminate the need for the issuance of new equity. Interest spend roughly take 10% of EBITDA, and foreign Exchange gain remain below 5%. It’s pretty steady and healthy.  The acquisition

expense was below 5% of revenue, means Zoetis’ growth was mostly organic growth, not by acquisition growth.

We expect the company to generate excessive free cash flow with ~$710 million this year on cash flow from operations of $910 million (up from $484 million last year as working capital needs decline by ~$400 million) and $200 million in net capex outside of restructuring costs and R&D. But given the margin improvement we see along with solid organic growth in the 5% to 7% range for the next three years, which should increase free cash flow to $1.4 billion by 2017. At that level of free cash flow, the shares are trading at over a 6.6% free cash flow yield. In 2016, the company paid out $188 million in dividends and repurchased $275 million worth of shares. R&D investment of $376 million.

We think the growth in margins and their overall top line organic growth should allow them to conduct several more Abbot Animal Health-like acquisitions over the near-term. The acquisition added approximately $100 million in revenue and nearly a nickel in earnings and was funded with free cash flow alone. We think they could add more acquisitions given our expected free cash flow inflection over the next two years. If no deals can be found, share repurchases could be ramped up and add some tailwind to EPS.

Management is also looking to improve margins. The company culled a large number of low-margin SKUs (stock keeping unit) in 2016 and has been restructuring its manufacturing footprint by closing plants. Over the next three to five years, that could drive gross margins into the high 60%’s and the SKU reduction should help a little on shrinking its working capital needs.

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Valuation

Sales Franchise Value Model: This valuation determines whether a company can repeat its business model at a lower cost. Franchise value is created when the company uses its competitive advantage to reinvest its earnings at a rate higher than the required rate of return. Given that Zoetis is projected to continue its expansion efforts and growth opportunities in the foreseeable future, the franchise value model is appropriate for identifying the company’s valuation. For calculation purposes, we use required rate of return 9%. The growth rate were estimated using the numbers derived in the Pro Forma Income Statement and projected shareholders’ equity, resulting in a 7% growth rate and profit margin from 12.06% to 17.72%. We get fair value $60, undervalued by 11% (Appendix 5).

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Implied P/E model: The Incremental P/E Model is trying to capture the company’s ability to reinvest its earnings at the superior rate. The model assumes that the extra return that the company produces above the required rate of return will continue forever. Given that Zoetis has pretty robust business model and has ride on global trend. We can expect in foreseeable future, it can keep growing in a steady pace. With expected EPS $2.78, sustainable growth rate 5%, and required rate of return 9%. We get fair value $61, undervalued by 13 % (Appendix 6).

The results of both valuation model is pretty consistent. After averaging both valuations, Zoetis Corporation’s fair value was found to be $60.5. This reflects an undervaluation of 12 %

Recommendation: Investing in Zoetis Corporation will provide the Roland George Investment Program portfolio with the unstoppable trend, which could have huge growth in the future. Along with the highly defensive nature, it will decrease the overall riskiness of the program’s portfolio. The animal health industry is particularly attractive since it is commonly overlooked by investors because it often overshined by those human pharmaceutical companies. Therefore, I recommend the program to BUY ZTS stock.

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