Estimates vary, but humans have likely had pets since dogs joined us in our first permanent settlements 25,000 years ago. Today, more than half of humans globally have at least one pet living with them. Awhile later, about 10,000 B.C., we got around to domesticating animals for food, and those animals needed taking care of, too.
IDEXX Laboratories (IDXX 0.09%) has been helping humans care for animals since it was founded in 1983. The company's original service was detecting diseases in livestock and poultry. It now provides testing and diagnostic equipment, as well as software for understanding tests or even managing a veterinary practice. But with the coronavirus affecting economies -- and food chains -- across the globe, investors are wise to ask, "Is this company recession-proof?"
Image source: Getty Images.
People keep spending on pets
Several factors can make a company resilient in the face of economic contraction, and all of them are focused around the stability of revenue. If a business sells something people must have regardless of the economy, or its customers just aren't affected by "the economy" as a whole, the benefits of this resilience will show up on the top line of the income statement. How does IDEXX measure up in this respect?
In a July 2020 survey conducted by the company, almost 90% of respondents said they would cut out dining in restaurants, personal grooming, and live entertainment to cover pet expenses if their household income declined. That's about as resilient as a business gets -- right up there with toilet paper and toothpaste. And the numbers back it up: In the last recession of 2008-2009, sales growth at IDEXX slowed, but didn't reverse.
Source: IDEXX Labs.
One common characteristic of stable businesses is that they tend to carry a lot of debt. Their predictable sales and profits allow them to borrow more than other businesses because they are much more likely to be able to pay it back. Unfortunately, if there are any hiccups in sales, these same businesses can quickly drown in the interest on the debt they've amassed.
How much debt is too much?
One straightforward way to measure the potential effects of a disruption in sales or profits is the interest coverage ratio. This is simply the company's operating income -- or profits after expenses such as people, materials, sales, and marketing -- divided by interest expense on its debt. For this ratio, higher is better. With IDEXX Labs, the ratio declined and then leveled off as the company borrowed money throughout the past decade.
| Year | Total Debt (in millions) | Interest Coverage Ratio |
|---|---|---|
| 2019 | $1,060 | 18 |
| 2018 | $1,000 | 14 |
| 2017 | $1,270 | 11 |
| 2016 | $1,200 | 11 |
| 2015 | $1,170 | 10 |
| 2014 | $900 | 17 |
| 2013 | $430 | 50 |
| 2012 | $210 | 69 |
Source: Morningstar; author's calculations.
A ratio of less than 3 is considered risky, so IDEXX's current interest coverage ratio shows that the company can still easily cover its interest payments. But it also shows the importance of predictable sales in the face of various economic conditions and competitive threats. It will be worth keeping an eye on how management addresses this debt in coming years.
It's a dog-eat-dog world
Resilient sales draw a lot of attention, and despite a strong position in the animal health market, the company has some impressive competition. When animal health player Zoetis (ZTS 0.88%) was spun out of Pfizer (PFE -0.19%) in 2013, much of its revenue was associated with animal dermatology. Management's 2018 purchase of Abaxis for $2 billion put it firmly in competition with IDEXX Labs in the veterinary diagnostics market and provided an instant international presence.
Today, Zoetis' $7 billion market cap and $5.3 billion annual revenue are both more than double that of IDEXX Labs, reflecting the former's strength in the animal health market. But that doesn't mean only one will succeed. This market is large and growing, estimated to increase by almost 6% per year through 2027 from $47 billion in 2019. With pet adoptions soaring through stay-at-home orders this spring and summer, that opportunity is likely to be bigger than pre-coronavirus expectations.
Getting back to normal-ish
While safety precautions affected the veterinary market in the spring, things are returning to normal. In an update to investors last month, management noted that veterinary visits are turning positive compared to last year. This growth in the face of economic uncertainty, and management's declaration of a $30 billion-plus addressable market for the company, has made investors willing to put a premium on shares. After paying between 30 and 50 times earnings for IDEXX Labs over the past decade, investors today are paying almost 70 times earnings for the same company.
Although the market is unpredictable in the short term, buying shares now would be more about safety than generating returns. Healthcare investors looking to grow their money rather than protect it are likely to be happier waiting for the market to present a better opportunity.
