Which of These Animal Health Companies Should You Invest In?

When investors think of major pharmaceutical companies, they don't generally think of animals. Yet, major pharmaceutical companies like Sanofi (NYSE: SNY  ) , Merck (NYSE: MRK  ) , and Eli Lilly (NYSE: LLY  ) all operate their own animal health businesses, and for good reason -- the world still spends one-fortieth of the amount it spends on human medicine on animal treatments for domestic pets and farm animals.

This makes animal treatments a comfortable sales cushion for pharmaceutical companies facing patent expirations and generic competition.

Let's meet the major players
Let's compare the animal health businesses of Merck, Sanofi, and Eli Lilly to the only pure animal health play in the market, Zoetis (NYSE: ZTS  ) , which was spun off from Pfizer earlier this year.

 

Animal Health Segment Revenue (most recent quarter)

Sales Growth (YOY)

Percentage of Total Revenue (most recent quarter)

Zoetis

$1.1 billion

2%

100%

Sanofi (Merial) 

$706 million

(5.7%)

6.7%

Merck (Merck Animal Health) 

$851 million

2%

7.7%

Eli Lilly (Elanco)

$544 million

6%

9.2%

Source: Company earnings reports.

Zoetis is the largest player in the market, although its sales growth, like Merck's, is slower than Eli Lilly's faster-growing, smaller Elanco unit. Meanwhile, Sanofi's Merial segment is the only business reporting negative sales growth in animal health.

Zoetis expands deeper into Asia
Zoetis is ideal for investors looking to focus purely on animal health products without the distractions of other human medications. Last quarter, Zoetis' revenue and adjusted earnings rose 2% and 3%, respectively, topping analyst estimates.

Zoetis has a diversified portfolio of medical treatments for veterinarians and livestock producers. Zoetis' livestock treatments accounted for 60% of its revenue last quarter, with the remainder generated by treatments for companion animals (cats, dogs, and horses).

Asia is a key area of growth for Zoetis. In Japan, it introduced a swine respiratory disease vaccine and an injectable antibiotic for cattle and swine. In China, it launched Convenia, an antibiotic for cats and dogs.

Most importantly, Zoetis recently announced that China's Ministry of Agriculture had approved the company's joint venture with the Chinese government to create a specialized swine vaccine designed to control PRRS, a reproductive and respiratory disease in hogs. Introducing a swine vaccine in China could significantly improve safety across the country, which has been plagued by ongoing food-safety problems.

Sanofi struggles against generic competition
Meanwhile, Sanofi's animal health unit, Merial, is still reeling from the patent expiration of its flea and tick medication Frontline four years ago.

In 2010, Frontline became the only billion-dollar franchise in the entire animal health market, but has since lost its market to generic competitors. Last quarter, a 14% year-over-year slump in Frontline sales was the primary cause of Merial's 5.7% top line decline.

On the bright side, Merial plans to introduce a successor to Frontline by next year, which the company claims will offer significant benefits over the original treatment. It also reported 11% sales growth in emerging markets.

Merial also recently signed an agreement to manufacture and sell Global Green's patented salmonella vaccine for chickens, which could significantly increase Merial's footprint in the poultry business.

Merck and Tyson part ways
Like Zoetis and Merial, Merck's animal health segment specializes in companion animal and livestock treatments. Merck recently announced the first swine vaccine for porcine circovirus, which can treat pigs as young as three days old to reduce mortality rates.

However, that good news was overshadowed by troubles with poultry and livestock giant Tyson Foods (NYSE: TSN  ) . On Aug. 7, Tyson banned the use of Merck's Zilmax, a non-hormone growth promoter that improves the conversion of cattle feed into leaner beef. The ban was not due to food-safety concerns, but rather lameness in cattle administered with Zilmax. 70% of cattle in the United States are currently fed non-hormone growth promoters, of which Zilmax is the market leader.

Merck responded by temporarily suspending the medication nine days later. It wasn't a major loss -- Zilmax generated $159 million in sales in fiscal 2012 and only accounted for 4.5% of Merck's animal health business. However, the questions raised by Tyson could have negative implications across the rest of the company's animal health portfolio.

Yet Merck's pain could be Elanco's gain
Merck's problems could directly benefit Eli Lilly's Elanco animal health segment. After Tyson halted the use of Zilmax, investors speculated that Tyson would switch to Elanco's rival non-hormone growth promoter, Optaflexx. Both Zilmax and Optaflexx can increase a head of cattle's weight by 30 pounds of lean meat prior to slaughter.

Although Tyson hasn't made a formal announcement about Optaflexx, Elanco stated that its customers were currently on a waiting list due to limited supplies caused by Zilmax's suspension.

Last quarter, Elanco posted impressive year-over-year sales growth ahead of its rivals, fueled by robust demand for Trifexis, a once-monthly chewable tablet for fleas, parasites, and heart worms in dogs.

The Foolish takeaway
You should consider the animal health businesses of Sanofi, Merck, and Eli Lilly to be safety nets to offset lost revenue from other products.

Investors who are only interested in investing in animal health products should consider Zoetis, which is making some serious gains in China and could benefit from tighter food-safety regulations. Zoetis obviously won't take off immediately on double or triple-digit growth -- its shares have only climbed 4% over the past 12 months -- but it could be a stable long-term investment as global demand for pet care and livestock products steadily increase.

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