It seems that one industry that has become highly defensive in recent times is the pet industry. It would appear that no matter how hard the economic situation has become, pets still get care and attention from their owners.
In addition, pets require almost constant medical attention as this guidance from the Royal Society for the Protection of Animals in the UK shows:
When puppies and kittens are born they are usually protected from infections by their mother's milk, providing she has been regularly vaccinated. However, this protection only lasts a few weeks so they need regular vaccinations from an early age.
Puppies are typically vaccinated at eight and 10 weeks, kittens at nine and 12 weeks, with an initial course of two injections. Your young pet should then be given a booster 12 months after their first vaccination.
Pet treatments are needed
So, like the market for human pharmaceuticals, pet treatments are in demand. In addition, demand for animal pharmaceuticals is not limited to dogs and cats. Zoetis (NYSE:ZTS), which was recently spun off from parent Pfizer, develops and produces animal health medicines and vaccines for livestock around the world. A more defensive play than a company that just supplies the pet market, Zoetis is experiencing near record demand for its products as beef and pork consumption rises in China and the African continent starts to develop -- there are now several large multi-national farming conglomerates operating on the African continent. Currently, Zoetis is only generating 2% of its revenue in China, but this figure should be set to rise dramatically in the near term.
Moreover, as this link shows, the number of animals around the world being farmed is going nowhere but skyward. It has become common practice for farmers to vaccinate their animals to stop the spread of disease, which can destroy hears and livelihoods.
Having said all of that, I believe that despite its defensive nature, Zoetis still looks expensive. Currently trading at 19.3 times forward earnings, the company looks overpriced when compared to competitors Pfizer, Sanofi, Merck, and Novartis, which all trade at average forward earnings multiples of 13.2.
Pet-related companies are highly sought after
Having said that, it would appear that in comparison to the rest of the pet-related sector, Zoetis is fairly valued. Peer MWI Veterinary Supply (NASDAQ:MWIV) trades at 27 times forward earnings, and again the company is highly defensive, engaging in the distribution of animal health products to veterinarians in the United States and the United Kingdom. Veterinary supply is exposed to the same demand factors as Zoetis -- greater demand for animal treatments will lead to more demand for the distribution of animal health products.
However, as with many distribution companies that do not manufacture the products themselves, MWI Veterinary Supply has a tiny net profit margin of only 2.8%, gross margin stands at 13%. The company is cash generative and paid down $52 million of debt during the second quarter, but it would appear that this was a one-off as for the past four years free cash flow has been minuscule or negative. MWI Veterinary Supply does not offer a dividend, but sales have expanded 121% over the past four years. Still, for 27 times forward earnings, I would prefer a stronger cash flow and perhaps a dividend.
PetMed Express (NASDAQ:PETS) is a pet pharmacy that markets prescription and non-prescription pet medications, health products, and supplies for dogs and cats. PetMed does offer a dividend, which currently works out to yield 4.3%, which is easily covered by free cash flow (apart from during Q1 2013 and Q4 2012 when the company paid out special dividends from its cash balance). The payout of $0.17 per quarter is costing the company roughly $3.5 million in total per quarter, free cash flow for the first two quarters of this year was $27.3 million compared to a total payout of $7 million.
PetMed has a gross margin of 66% and a debt-free balance sheet, in fact the company has $50 million of cash and short-term investments as of the end of Q2, 16% of the company's $317 million market capitalization. Furthermore, PetMed trades at the lowest valuation in this piece, a forward earnings multiple of 16.7 makes the company look cheap for the sector and in comparison to its return on assets, which stands at 23% -- high for most industries.
All in all, the demand for animal treatments -- in particular, those for pets -- is continually rising around the world, and these three companies are benefiting.
However, due to their defensive nature, both Zoetis and MWI Veterinary Supply look very expensive and don't really offer much in the way of a dividend. On the other hand, PetMed offers a strong 4.3% dividend yield, well covered by free cash flow, and the company trades at a low forward valuation in comparison to the rest of the sector.
Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!