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I’m a big fan of the animal health sector but not necessarily the
stocks within it. The sector looks set for good long term growth as
demographics and socio-economic trends are working in favor of
increasing numbers of companion animals. Aging populations and
increasing numbers of single parent families along with decreasing
marriage rates all add up to the increased proclivity to acquire pets as
a form of emotional supplicant. But how to benefit from this trend?
Sector Attractive but the Stocks are not, for Now
With that said, it is somewhat frustrating that the stocks within the
sector do not seem particularly attractive. I first looked at the
sector in an article linked here and
at the time concluded a few things regarding the companies discussed.
The central theme is that they all seem to have been affected by a ‘pull
forward effect’ whereby the unseasonably warm weather in the winter
encouraged visits to the vets, which then fell back in the second
quarter. As ever, investors bought the false optic and then got
disappointed.
I’ve summarized the key issues to look for going into earnings season from the stocks in the sector.
PetsMart(NASDAQ: PETM) needs to keep up high growth rates in order to justify competition, particularly as Wal-Mart(NYSE: WMT) and Amazon.com(NASDAQ: AMZN) are beginning to encroach on their marketplace.
Idexx Laboratories (NASDAQ: IDXX) needs to demonstrate its patient visits, and practice revenue numbers can snapback from the Q2 dip
VCA Antech (NASDAQ: WOOF)
has to demonstrate that it can reaccelerate revenue growth in lab and
animal hospital revenues and that it is dealing with competitive threats
without destroying margins.
Now it’s time to look at the report card.
VCA Antech: Is Competition Starting to Bite?
I’ll start with VCA Antech, which, as the following graph
demonstrates, generates most of its revenues from hospital visits, but
the highest margins are in its lab operations. First up, revenues.
And now Gross Profits.
The story of VCA Antech’s results is of sequential improvement in
margins, but that is surely to be expected after such a poor Q2. On a
yearly basis, things don’t look so good. Lab growth rates were 5.2%
(warm weather induced) but fell to 2.6% in Q2 and only increased 2.5% in
Q3. Meanwhile, hospital growth rates increased 1.1% from being flat in
Q1. Management talked a lot about the macro-economy amidst hope that it
would improve, but I think there is a case to be made for its
difficulties being part of the competitive environment.
Wal-Mart and Amazon.com are both expanding their pet related
offerings, and offering prescriptions is a sure way to eat into the some
of VCA’s revenues. Indeed, the animal hospital category is competitive
enough already, and by its own admission VCA Antech is not the cheapest
supplier out there. Of course, less hospital visits mean less revenue at
VCA’s labs, so this is a significant challenge. Moreover, the company
has been an acquisition binge and I think caution needs to be applied
with this sort of thing. Small practitioners can always find a way to
set up elsewhere in the locale, and it appears that the acquired
businesses are lowering margins overall.
Idexx and PetSmart’s Report Card
In terms of animal health, Idexx pretty much confirmed that the Q1
pull forward effect was real. I’ve summarized patient visits and
practice revenue growth below.
Unfortunately, it looks like there was no economy-led pick up in
patient visits in Q3. Revenues in Idexx’s Companion Animal Group did
grow 5.7%, but this was mainly due to 7% organic growth in lab
diagnostics, consulting services and instrument and consumables. In
turn, this was largely caused by a combination of acquisitions, price
increases and geographic expansion. This is fine for Idexx but it is not
indicative of a strongly growing marketplace. Throw in the hefty
evaluation and it’s hard to conclude that Idexx is attractively priced.
PetSmart is the business with the most to lose from Wal-Mart and
Amazon’s encroachment, however there is no sign of it hurting the
company yet. On the contrary, comparable same store sales growth was at a
healthy 7% and transactions rose 2.9%. It is interesting that PetSmart
is able to generate such strong growth in sales. Clearly, it is doing
the right things to leverage footfall, or maybe its customers come from a
demographic that is more inclined to open up the purse strings?
The Bottom Line
I think there is clear evidence that competitive pressures are
starting to hurt prospects at VCA Antech and the pull forward effect was
a real one for the whole industry. Idexx is performing well, but the
stock remains expensive. PetSmart remains the best stock in the sector,
but I fear it is a matter of time before online competition from
Amazon.com and in turn Wal-Mart starts to leverage its own footfall.
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