At VCA's massive West Los Angeles Animal Hospital, your pet can get chemotherapy and MRI scans, receive acupuncture and Chinese herbal treatments, rehab on an underwater treadmill or be entered into behavioral counseling, as well as join a weight-management regimen. Dogs, cats, rabbits, birds of prey, potbellied pigs: all welcome there.
The hospital offers high-profile proof of a thriving pet-health industry, or what analysts call the "companion animal" business. Nearly two-thirds of U.S. households own a pet. But that percentage is constantly rising. So is the amount that the U.S. population is expected to spend on its pets -- a cool $63 billion this year, according to the American Pet Products Association. Adoptions are up nationwide. The number of animals euthanized is down, and analyst surveys indicate that most veterinarians expect their practices to keep growing.
As demand rises, the pet industry has expanded to meet needs: Drugmakers Zoetis (ZTS) and Abaxis (ABAX), high-quality pet food maker Blue Buffalo Pet Products (BUFF), diagnostics provider Idexx Laboratories (IDXX) and pet health insurer Trupanion (TRUP). The new products and services are there, and pet owners, heeding their veterinarians' advice, have been willing to spend.
"I don't think it's that they didn't want to take care of [pets] in the past," Stifel analyst Jonathan Block said. "I think just advancements in medicine and surgeries have allowed people to take better care of them."
The expansion has been led by a generation of baby boomers who have become empty-nesters and seek out pets for company. Many younger adults have also put off marriage, opting for the "cats, not kids" approach to family. And dog parks have become increasingly popular safe zones in which pets and a broad range of owners can mingle.
"Several decades ago, it was pets in the backyard. Then it was pets in the house, and then sitting beside you at the dinner table, and then sleeping in your bedroom," Credit Suisse analyst Erin Wilson said. "It's that progression that has increased overall willingness of pet owners to maintain their pets."
The 'Premiumization' Of Pets
The combination of pet ownership and finance has resulted in some peculiar turns of phrase in earnings announcements. "Reptile is sort of in an upswing," pet-supplies seller Central Garden & Pet (CENT) noted last month, and the company is experiencing a "premiumization in dog and cat." Blue Buffalo, meanwhile, has been helped by "new innovation in our wet foods treats and meat rolls." Pet insurer Trupanion last month remarked that "total enrolled pets (including pets from our other business segment) was 307,298 at quarter-end, up 25% over the prior year period."
Language notwithstanding, the reports all point to an industry that held up well, comparatively, even during the recession. While the recession urged many human health-care consumers to delay their own health care -- and shoppers to downgrade their family's food purchases -- sales of higher-end pet food and services proved much more durable.
"The trade-down in pet care was still much lower than you were seeing in areas like the grocery store," Gabelli & Co. analyst Kevin Kedra said. "You were much more likely to get the store brand cornflakes and mac-and-cheese than you were to get store-brand dog or cat food."
Stocks within the companion-animal industry are all over the map this year. Zoetis and Abaxis are down for the year. Thinly-traded Central Garden & Pet is up 65% since Dec. 31.
Several group leaders are also up for the year, have held above their 50-day lines and maintain strong Composite Ratings from IBD. VCA, which runs a network consisting of hundreds of animal hospitals and dozens of diagnostic labs, has led the charge.
The vast majority of U.S. veterinary practices, estimated to be at least 25,000, aren't corporate owned. Thus, VCA's acquisition opportunities remain numerous, and its size facilitates the process.
"It's much easier for an independent practitioner to sell to VCA than to cobble together a group of vets to buy out the practice," Morningstar analyst Debbie Wang wrote in a research report.
VCA also stands to gain from opportunities in higher-margin services, she said, like dermatology, dentistry and ophthalmology.
"Five years ago, a dog undergoing ACL surgery would certainly not be the norm," Block said.
To enhance that trend, VCA has put more effort into training vets to be more tech-savvy and business-savvy, Wilson said. The aim: keep them abreast of more advanced -- and more expensive -- forms of treatment. VCA also attends to smaller details, like sending out text reminders for appointments, which can reduce the number of cancellations.
Wellness programs -- which customers can pay into over a longer period of time in exchange for checkups, tests and other services -- help reduce sticker shock. New lab tests can produce results within minutes, and roughly half of diagnostic testing is done in-house, as opposed to a decade ago when most of those tests were sent to labs. Even when an outside lab needs to take care of something, couriers for VCA or Idexx pick up samples twice a day, Block said.
Analysts say that Idexx, VCA's primary competitor on reference-lab resources, has developed the more-innovative equipment. One such new test, SDMA, is designed to provide early detection of kidney disease -- a leading killer of both dogs and cats.
Idexx offers the Catalyst One, a breadmaker-size device that can process samples and generate results in as little as eight minutes. The Catalyst is geared toward smaller, less-busy hospitals, and can help draw them into more advanced in-house diagnostic testing, Wilson said.
Idexx also offers IT programs that bring together test data from reference labs and vet clinics, making it easier for practices to analyze results.
Betting On Chewables
Analysts say the companion business remains largely cash-based and is isolated from issues that complicate human health care -- regulations, generic drugs and the tug of war between insurers, drugmakers, hospitals and customers. Its growth has also outpaced that of the human health-care industry.
On the drugmaker side of the pet health business, some of that growth has been helped by companies like Zoetis, a spinoff of Pfizer (PFE), and Abaxis. Among the potential blockbusters are Zoetis' Apoquel. The oral drug treats a type of allergic dermatitis in dogs and could bring in up to $300 million a year in sales.
Zoetis has also introduced Simparica, a chewable flea and tick drug for dogs. Merck has a similar product, Bravecto. Sanofi's (SNY) veterinary unit Merial offers the chewable NexGard treatment, and also manufactures the topical flea medication Frontline. Chewable drugs avoid the mess -- and toxicity – of external meds applied to a dog's back, and bypass the challenge of administering tablets.
The Nemo Effect
Companies that make drugs for animals also benefit from an easier, far less expensive Food & Drug Administration approval process. Zoetis largely sells directly to veterinarians, who then sell the drugs to pet owners. Smaller rivals often use distributors like Henry Schein (HSIC), VCA's primary distributor, or MWI Veterinary Supply, which distributor AmerisourceBergen (ABC) bought last year in attempt to tap into the market.
"We have drugs that were studied in animals and that's how we got them into human trials, and now we're bringing them back to the animals," Kedra said.
Acquisitions have helped elsewhere. Central Garden & Pet agreed in December to buy the pet bedding business of National Consumer Outdoors. In July, it also bought up nearly all of IMS Trading, which makes Cadet brand dog treats. Those purchases came on the cheap, and might have been the reason why the company raised recent sales and earnings forecasts, GARP Research analyst Bill Baker wrote in a May research note.
Central's Nylabone is known for its dog bones and other chewables. Nylabone also makes Nubz dog snacks, which GARP sees giving Greenies, a treat loved by dogs and cats alike made by Tennessee-based Nutro, a run for their money. In addition, Central produces so-called insect-growth regulator compounds, which interrupt the life cycle of a pest and which GARP says local governments could potentially use to combat the spread of the Zika virus.
Even "Finding Dory," the sequel to the movie "Finding Nemo," could help lift sales in the company's large aquatics business.
"The original movie stimulated aquarium sales so much that the industry has been reeling ever since enthusiasm waned," GARP analyst Bill Baker wrote in a May research note.
Minding Fifi's Insurance Fees
Within pet insurance, Block said, Trupanion offers plans that pay 90% of a pet's medical invoice, as opposed to plans with less flexible, fee-based schedules that alienated veterinarians in years past.
"The reason why pet insurance has flopped in North America for many, many years is that it was fee-based," Block said. "And what that means is, literally, there's a fee schedule, and the insurer looks up ACL surgery and they're gonna pay $1,100 dollars whether that ACL surgery took place in midtown Manhattan or Omaha, Nebraska. And that's a problem."
Trupanion is also introducing some direct-pay plans. In those plans, the company directly pays the veterinarian the 90% they agree to cover, doing away with the standard reimbursement process in which the pet owner shells out the full amount to the clinic and then waits for the insurer to repay their due portion.
Looking ahead, if the economy teeters into a recession, pet spending could fall. According to Morningstar, Idexx makes a lot of money internationally, so the strong dollar could weigh on its results. As VCA grows, it risks coming across as a corporate-acquisition machine indifferent to locals, the investment firm also noted.
The pet insurance market, however, is between 1% to 2% penetrated, analysts say, which gives Zoetis or VCA more sway over prices. Malpractice lawsuits are rare, and costs related to bad debt are lower than those found in hospitals for humans, Morningstar said.
"You don't have worries about what Hillary Clinton is going to do on drug pricing and Medicare," Kedra said. "That doesn't matter on the pet side."
