How Much is that Doggy in the Window? Fetching Profit in the Pet Care Industry

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By Jason Simpkins
Associate Editor

Last year, Pfizer Corp.'s (PFE) animal health unit introduced the drug SLENTROL in the U.S. market as a way of dealing with doggy obesity. The drug succeeded in helping the canine community shed something besides fur, and is now destined for a debut in Europe.

Experts estimate that 25% to 40% of Europe's dogs are overweight or obese – it's probably all that fine French cuisine – making them vulnerable to such long-term health problems as heart disease, diabetes and osteoarthritis. Veterinarians agree that diet and exercise play the biggest role in a dog's health, but few dog owners are conscientious enough to regulate their dog's behavior.

"When I talk to them about diet and exercise, it's probably 95% to 98% unsuccessful," Scott McComb, a doctor of veterinarian medicine at the McQueen Vet Clinic in Arizona, told Business Wire. "They all leave saying ‘I'm going to feed less and exercise more' and it's amazing to me how often that doesn't work."

By investing the time and money needed to develop a drug for the pet market, Pfizer Animal Health acknowledged an emerging reality: Consumers are willing to spend big money on their pets.

According to the American Pet Products Manufacturers Association, an estimated $40.8 billion was spent on pets last year, an increase of 6% from the $38.5 billion spent the year before.

And that's just in the United States, where about 63% of households own a pet.

"It's a substantial market," said Eugene Fram, the J. Warren McClure Marketing Research Professor at the Rochester Institute of Technology College of Business. "The numbers bear that out with more than 60% of households having a pet. It's a good business and a great target market" to pursue.

Thanks to the understanding of that market, its stability and some major advances in technology, the companies that are pursuing the pet market are becoming more and more sophisticated in terms of the niches they choose to focus on and the manner in which they operate.

One example is the Pompano Beach, Fla.-based PetMed Express Inc. (PETS), a pet medication delivery company focusing on the U.S. market.

The company is experiencing frenetic growth, stating that its earnings for the third quarter soared to $4.4 million, a jump of 60% from the comparable quarter a year ago. Third-quarter sales were $37.3 million, up a healthy 19% from the third quarter a year ago. As it's grown, it's worked to tighten up its operations, too, and in the quarter trimmed its operating expenses to $8.87 million from the prior level of $8.92 million.

As of the end of December, the company had more than $1.90 per share in cash.

PetMed's shares closed Friday at $12.52 each, down 2.42% for the day. In the last 52 weeks, the stock has traded as high as $15.98 and as low as $10.45.

The company added 127,000 new customers during the quarter. Earnings have topped the consensus in seven of the last eight quarters. For the fiscal year that ends in March, analysts are projecting earnings of 79 cents per share, an increase of 32%. For fiscal 2009, per-share profits should approach 87 cents, an increase of 10%.

On Thursday, Zack's Investment Research listed PetMed as a "Buy," ranking it as an "aggressive growth" stock.

"PetMed Express has certainly not been in the doghouse," Zack's said in its research note. "The industry is booming as people continue to pamper their pets."

Also worth noting:

The earnings estimates for the year have risen three cents each to 79 cents.
Next year's estimates also have risen three cents.
Four of the five analysts covering the firm also have boosted their forecasts.
PetMed has posted an earnings surprise averaging 15.5% over the past four quarters.

PetMed's shares closed Friday at $12.52 each, down 2.42% for the day. In the last 52 weeks, the stock has traded as high as $15.98 and as low as $10.45.

Another pet-oriented healthcare service that's found an important niche to fill is VCA Antech Inc. (WOOF). The Los Angeles-based VCA owns, operates and manages the largest network of veterinary hospitals and clinical laboratories in the country.

VCA Antech's diagnostic testing facilities serve 15,000 clients across the nation. According to the Associated Press, Morningstar analyst Debbie Wang referred to the diagnostic labs as the company's "crown jewel, a super high-margin business" which has proved extremely profitable.

Earlier this month, VCA Antech announced preliminary fourth quarter earnings of 28 cents to 29 cents per share and said that its earnings per share for the full year, which was in line with analysts' estimates.

However, the threat of a recession forced the company to lower its earnings forecasts for the next year. VCA projected that its earnings per share for 2008 would be $1.55 to $1.60 per share, well below the consensus of $1.63 according to Forbes.

The EPS estimates for 2008 and 2009 have been reduced from $1.62 to $1.57 and from $1.86 to $1.81, respectively, to reflect the reduced animal hospital same-store sales estimate and operating profit margin estimates, according to analyst Ross Taylor of CL King & Associates.

Earlier this month, Taylor reiterated his "Strong Buy" rating on VCA Antech, although he reduced this target price to $47 from his previous estimate of $50. A lower-than-expected rate of revenue growth for the company's labs for the quarter was the culprit for the reduced earnings estimates and was the chief reason he lowered his target price, Taylor said in his research note.
The stock closed Friday at $32.52. Its 52-week trading range is $30.04 to $46.23.

While VCA Antech has made their mark in the U.S. market, Pfizer Animal Health is going global.

In developing its marketing push for Europe, the company conducted an online survey of 1,500 pet owners throughout Europe and discovered that only 22% had even tried to get their dog to lose weight.

SLENTROL is just part of a new campaign from Pfizer Animal Health to tackle canine obesity – and turn a profit in the process. The drug comes in liquid form and can be easily added to the dog's food once a day.

Tens of thousands of U.S. dog owners have signed on to www.StopCanineObesity.com to use Pfizer's Body Assessment Rating for Canines (BARC).

As marketing programs go, Pfizer's BARC apparently also has some serious bite. Pfizer Animal Health generated $785 million in sales in the fourth quarter of 2007, a 20% jump from sales of $655 million in 2006. For the full year, Pfizer Animal Health revenue totaled $2.6 billion, an increase of 14% from 2006.

The corporation overall last year earned $8.3 billion on sales of $48.6 billion.

Pfizer remains the "Top Pick" of Goldman Sachs Group Inc. (GS) as the brokerage firm upgraded its rating on the large-cap U.S. pharmaceutical group from "Neutral" to "Attractive." According to Goldman, the sector's year-to-date performance has created a buying opportunity.

Price/Earnings ratios "now sit near 15-year lows, dividend yields are near 15-year highs, and our discounted cash flow valuation suggests meaningful upside potential across the group," Goldman said in a note to its clients.

Goldman has a target price of $28 on Pfizer's shares. That would represent a 25% return from Friday's closing price of $22.33. Plus, Pfizer's current dividend yield is 5.7%.

One question investors may have is how well consumer spending on pets will hold up if the U.S. economy slips into a recession. RIT's Fram believes that spending won't decline much. Pets are usually viewed as family members, meaning there would be little thought of skimping on food or medical care. Also, a lot of the heavy spending in this sector stems from higher-net-worth consumers, who can better-afford to keep spending, he said.

And even if there is a slight reduction, it's reasonable to assume that the long-term outlook for this industry is positive. Pets will always have a home in a market dominated by single people, small families, and empty-nesters.

"If economic conditions are good and people feel like they're getting ahead, I would predict that folks will be happy to spend money on their pets," Morningstar's Wang said.

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