Former Pfizer (click ticker for report: ) business unit Zoetis (ZTS) announced solid second quarter results Tuesday morning. Zoetis is relatively new as a public company, and this was the first time it reported results as a completely separate entity. Zoetis focuses on animal nutrition for both livestock and domesticated animals and is among the few animal nutrition “pure plays” available to investors. In the period, revenue increased 2% on a year-over-year basis (4% excluding currency), to $1.1 billion, roughly in-line with consensus estimates. Adjusted net income per share rose 3% year-over-year to $0.35, also consistent with consensus expectations.
The majority of Zoetis’ revenue comes from the US (39% in the second quarter), where revenue grew 4% year-over-year to $437 million. The increase in sales was driven by 6% growth in revenue derived from livestock. Revenue in the Europe, Middle East, and Africa region was down slightly on a reported basis coming in at $278 million, but it increased 1% when excluding currency fluctuations. The firm’s Canada and Latin America segment revenue advanced 4% year-over-year on an operational basis, to $213 million, while its Asia-Pacific segment revenue increased 7% year-over-year excluding currency to $186 million.
Asia-Pacific could be a strong growth region in the future, particularly China. CEO Juan Ramon added some encouraging commentary, saying on the conference call:
“I’m pleased to confirm an important milestone with our joint venture in China. July saw the approval for RUI LAN AN a new high standard of innovation against a highly pathogenic porcine reproductive and respiratory syndrome. The vaccine combines the global expertise of Zoetis and a strong local vaccine and developmental program to address the needs of swine products in China. They are a leading pork production nation.”
We were initially concerned about the firm’s headline gross-margin compression, as the measure fell 270 basis points year-over-year, to 62.7%. Even on an adjusted basis, gross margins declined 100 basis points year-over-year, despite increased prices during the first quarter. CFO Rick Passov was able to address the issue, however, stating on the conference call:
“…as I called out in my comments we have a third party manufacturing business that almost exclusively relates to our having to supply product for divested products to those companies that bought those products; these were mandated divestures as part of the Pfizer acquisition of Wyeth and our acquisition of Fort Dodge which was a part of that, and the seasonalization of those orders versus the prior year causes a year-over-year comparison that’s unfavorable; and then finally the carve-out financials in the prior year have some anomalies in them in part the progression of just better understanding how to allocate center cost and Pfizer to animal health.”
In other words, the issue seems to have come from pro-forma financials. Because Zoetis wasn’t run as its own entity within Pfizer, management wasn’t exactly sure how the cost structure would look when it operated on its own. As such, comparisons looked a bit unfavorable.
This type of phenomenon, albeit of the favorable variety, also occurred with non-GAAP adjusted SG&A, which declined 170 basis points year-over-year to 30.4% of sales. It will probably take a full-year of reporting without Pfizer for us to get a real feel for exactly where the cost structure should be, but we think the 2013 numbers are more accurate than the estimates used for 2012.
Looking ahead, management reiterated its full-year revenue guidance of $4.425-$4.525 billion driving earnings per share of $1.36-$1.42. Both figures are roughly in-line with current Street expectations.
Valuentum’s Take
Zoetis is a very intriguing firm, particularly since it focuses on a relatively obscure segment of the pharmaceutical market. At this time, the Health Care ETF (click ticker for report: ), Intuitive Surgical (click ticker for report: ), and Teva Pharmaceuticals (click ticker for report: ) represent our exposure to the healthcare sector in the portfolio of our Best Ideas Newsletter.