Zoetis Stock: 3 Key Investing Lessons from 2013

Animal health company Zoetis (ZTS 1.64%) has had a lackluster year since its spinoff and IPO from Pfizer (PFE -3.85%), rising barely more than 1% since February.

Meanwhile, investors who scooped up IPO shares of Zoetis at its initial price of $26 are sitting on a 21% gain, following some volatile bounces in a wide 52-week range from $28.81 to $35.42.

Source: YCharts.

What three investing lessons can we learn from Zoetis' flat performance in 2013? Does this company have a bright future ahead of it in 2014?

Lesson No. 1: Spinning off non-core businesses can boost a company's bottom line
Pfizer's spinoff of Zoetis into a new publicly traded company was a brilliant move for three reasons:

• Zoetis' animal health business didn't fit in with Pfizer's other pharmaceutical businesses.

• A spinoff, rather than an outright sale, helped Pfizer avoid a large tax bill.

• By allowing Pfizer shareholders to exchange their Pfizer shares for Zoetis shares (at a 1:0.9898 ratio), Zoetis started out with a more established investment base than other newer companies.

As a result of Zoetis' IPO, Pfizer decreased its full-year revenue guidance by $4.5 billion and its full-year earnings by $0.04 per share.

However, spinning off the company was an essential part of Pfizer's strategy to sell other non-core businesses, such as its Capsugel unit to KKR in 2011 and its baby food unit to Nestle earlier this year. All these sales and spinoffs were aimed at coping with the loss of Pfizer's blockbuster cholesterol drug, Lipitor, which generated peak sales of $13 billion in 2011, the same year it lost U.S. patent protection.

Pfizer's strategy is now being mirrored by Novartis (NVS 0.72%). The company recently announced that it was ready to sell its animal health unit, which generated $1.1 billion in revenue last year, to interested buyers, including Bayer, Merck (MRK 2.93%), and Eli Lilly (LLY -1.00%).

If Bayer acquires Novartis' animal health unit, it would boost its market position from fifth place to either third or fourth, with combined annual veterinary sales of $2.8 billion. Meanwhile, if Merck were to acquire Novartis' business, it could overtake Zoetis' top spot by boosting its annual revenue from $3.4 billion to $4.5 billion. Lilly could also jump from third place to second place, with its annual revenue climbing from $2.8 billion to $3.9 billion. Zoetis, by comparison, generated $4.2 billion in revenue last year.

Due to those high stakes, Novartis' animal health segment could fetch a high price tag -- more than $4 billion.

Lesson No. 2: Zoetis is still the dominant leader in animal health
Until such a deal closes, however, Zoetis is still the top name in animal health. Simply compare its quarterly revenue growth against that of its closest competitors, Merck and Eli Lilly.

Source: Company quarterly reports.

Zoetis has also been growing globally, reporting positive sales growth in all four of its global regions.

Source: Zoetis Q3 report.

Zoetis reported strong demand for livestock products, such as treatments for cattle, swine, and poultry, although sales of companion animal products rose across all regions as well.

Lesson No. 3: China's demand for pork could be the key to Zoetis' future
Although Zoetis' Asia-Pacific business is its smallest and slowest growing segment, I believe that investors should keep a close eye on its growing presence in China.

In August, Zoetis' joint venture in Jilin, China announced the launch of Rui Lan An, a specialized swine vaccine for porcine reproductive and respiratory syndrome. PRRS causes reproductive failure during late-term gestation in sows and respiratory conditions in pigs of all ages. Back in 2006, a new strain of PRRS emerged, adding high fever, skin discoloration, and a high fatality rate between 20% and 100% to the already devastating disease. As a result, roughly 20 million pigs (3% of China's swine population) must be culled annually.

China's massive demand for pork fueled Hong Kong-based Shuanghui's $4.7 billion purchase of Smithfield Foods, the world's largest hog and pork producer, earlier this year. However, China's food safety problems, such as the 10,000 diseased pigs that washed up in Shanghai in March, are causing the public to seriously question the ability of the government to guarantee their safety.

Therefore, China is the ideal market for Zoetis to thrive in, since it has already proven its ability to address one of the worst problems facing pig farmers in the country.

Although Zoetis has been in China since 1995 as part of Pfizer, its operations are still fairly small and have plenty of room to grow. Therefore, I wouldn't be surprised if the company's Asia-Pacific sales eventually overtake those of its other regions in growth and importance.

The Foolish takeaway
Looking ahead, I believe Zoetis investors should keep an eye on two things -- if the sale of Novartis' animal health unit gives its rivals a boost that could threaten its leading position in the market, and its growth in Asia, which will be fueled by the simultaneous demand for more meat and better food safety.

In closing, although Zoetis has gotten off to a very slow start in 2013, I think investors should have some patience with the stock and consider it a solid long-term investment.