Animal health company Zoetis (ZTS -4.32%) makes medicine, vaccines, genetic tests, and other products that together generate around $8 billion in annual revenue. More than 60% of its revenue comes from companion animals (like dogs, cats, and horses), with the remainder coming from its livestock segment. Its business is diverse with around 300 products, including 14 key ones that generate at least $100 million in annual revenue.
Despite the stability, the healthcare stock fell 40% last year as it significantly underperformed the markets (the S&P 500 declined 19%). Has Zoetis become a bargain buy for 2023, or is there more pain ahead for the healthcare stock and its investors?
Sales growth has come to a grinding halt
Zoetis has been averaging a solid and consistent growth rate of around 9% over the past few years, but that has fallen sharply in the company's most recent quarter.
ZTS Revenue (Quarterly YoY Growth) data by YCharts
The company's surge in sales last year was due to a recovery from the prior-year period. The early stages of the pandemic had a negative effect on its bottom line, and a year later, there was a subsequent recovery. Other than that, the business has for the most part shown good stability.
But in its most recent earnings report, for the period ended Sept. 30, 2022, the company's growth rate was down to less than 1%. Zoetis noted multiple headwinds, including supply chain issues, foreign exchange (Zoetis generates close to half of its revenue from markets outside of the U.S.), and veterinary workforce challenges as reasons for the lackluster growth.
As a result, the company also lowered its expectations for the year, projecting that full-year sales will be around $8 billion to $8.1 billion (versus the range of $8.2 billion and $8.3 billion it was forecasting just a few months earlier). At $8 billion, that would represent a year-over-year growth from 2021 of just 2.9%.
Margins are terrific and the dividend looks safe
Although the company's growth rate has been struggling, the positive is that Zoetis runs an incredibly profitable business and normally has no trouble staying in the black.
ZTS Profit Margin (Quarterly) data by YCharts
Another important aspect of the business is that Zoetis generates plenty of free cash flow. That's important, as it can help the company fund its own growth. It also allows the company to pay a modest dividend yield of 1%. Zoetis announced a 15% increase to its dividend last month, and its payout ratio sits at a relatively modest 28% of earnings.
ZTS Free Cash Flow (Quarterly) data by YCharts
Should you buy Zoetis?
Zoetis looks like it should be a profitable, long-term investment as its fundamentals are promising. But the big obstacle for me would be its valuation. Even though the stock has nosedived, it's still trading at a price-to-earnings multiple of 33, which is well above the S&P 500 average of 18.
The healthcare stock would need to endure more of a decline before being a good buy, especially given its struggling growth rate. Even over the past few years, the company hasn't been growing at a rate that would justify such a large premium. Until Zoetis gets down to a more reasonable valuation, this isn't a stock I would buy just yet.
