A few weeks ago, a colleague came in to the office looking harassed. He'd had a dreadful weekend as the family guinea pig had died and his children were distraught. This sparked a wider discussion of extravagant pet stories. One colleague once spent £100 on a course of antibiotics for a hamster, another had made an entire Christmas stocking for the family dog, and one revealed - to much hilarity - that he talks to his cats and voices their responses.
Pets are clearly worth a great deal to their owners and that's one of the reasons why the veterinary healthcare market has grown so quickly over the past few years.
Simon Innes, chief executive of CVS Group (CVSG), has witnessed that growth first hand, as his company has developed into the largest owner of veterinary practices in the UK. "There's been a widening of activity in my time," he said, referring to the rise in consolidation of general practices, specialist hospitals and night emergency clinics in the past 20 years, "and the worth of veterinary practices has gone up enormously."
It's not just in the UK that this trend is evident. Globally, the animal health market is worth an estimated $24bn (£19.7bn) and is expected to grow at a rate of 5 per cent a year for the next decade.
A dog is for life
The UK is home to 8.5m pet dogs, roughly 1.3 dogs for every household. The domestic cat, fish and horse population of the UK is also recorded into the millions, and it's been estimated that 40 per cent of Britons own a pet.
But the companion animal health market isn't thriving due to the number of animals. In fact, pet population in the western world has fallen in the past few years. Instead, market growth of roughly 5 per cent has been driven by a rise in expenditure per animal, particularly in food and healthcare.
Insurance is also on the rise, with an estimated 3.9m dogs and cats in the UK now covered by pet insurance. In the past 10 years, the average claim has nearly doubled to £720, while the number of claims rose by 9 per cent between 2014 and 2015. Thus the UK pet insurance market is now worth £657m. But with only 25 per cent of dogs and 15 per cent of cats covered, there's room for further growth here. That's why CVS is launching its own insurance package later this year. Insurance policies have also become more extravagant. For example, Pets at Home's (PETS) 'ultimate' Pet Plan policy covers vet bills of dogs or cats to a value of £12,000 per year.
Human-like healthcare
Better quality insurance has given rise to a market for more sophisticated veterinary pharmaceuticals, too. Today, companion animal treatments include oncology, endocrinology and dermatology products. Dechra (DPH) - one of Britain's largest veterinary pharma companies - offers 177 different companion animal pharmaceutical products on its website. There's even a market for animal obesity and diabetes, as pets have started to be afflicted with the same lifestyle illnesses as their owners.
Like the human healthcare market, the launch of a novel, branded animal drug can mean big financial rewards for a veterinary pharma company. That's why Animalcare (ANCR) has invested in its own drug development programme. But, according to Dechra's chief executive Ian Page*, there are "very few innovators" and many companies at play in the generic copycat market. This has created a competitive marketplace, prompting Dechra to up investment in research and development.
Pet preventative healthcare - which includes vaccinations against worms and fleas - is also a growing specialism in veterinary pharmaceuticals. CVS, Premier Veterinary (PVG) and Denplan are three of the largest players in the market, with 253,000, 139,000 and 500,000 members, respectively.
Farming
But companion animals only paint half the picture. Farm animal expenditure makes up 51 per cent of the global animal healthcare market and - arguably - has even better growth prospects.
The catalyst is demand for meat. Humans - particularly in the western world - are big meat eaters and an expanding population is putting pressure on farmers to increase production. But, with livestock already occupying 30 per cent of the earth's free space, herd or flock expansion is becoming harder.
Instead, farmers are turning to science to improve the productivity of their animals. According to Karim Bitar, chief executive of animal genetics group Genus (GNS), the pig per sow per year ratio (PSY) is crucial in porcine breeding. Genus' pigs are in high demand as their genetic characteristics ensure pigs produce an average of 28 piglets with every birth. Anpario (ANP) and Wynnstay (WYN), which both produce and manufacture farm animal feed, have seen a rise in demand for their bulking products too, which increase the amount of meat per animal.
But nowhere is demand rising faster than in emerging markets, where higher GDP and individual spending power have given rise to a whole new population of affluent meat eaters. This has been reflected in companies with operations in the developing world. Genus recently reported a 138 per cent rise in operating profit in its Asia division, for instance, while Latin America is fuelling growth for Anpario and China presents a big opportunity for fish farming specialist Benchmark (BMK).
But one of the biggest challenges facing both animal and human healthcare today is the rise in antibiotic resistance. As it's now widely accepted that overuse of antibiotics in meat-producing animals has been one of the main causes in the rise of the 'superbug', global governments have clamped down on their usage in farms. In Europe, it's now forbidden to use antibiotics for anything other than bacterial infection and vets must ensure that the antibiotics have completely passed through an animal's system before it is sent for slaughter. Dechra's antibiotic sales have suffered as a result of this. But ECO Animal Health's (EAH) drug Aivlosin has reported significant sales growth, as it contains a novel antibiotic, effective against antibiotic-resistant bacteria.
A global market ripe for consolidation
Rapid consolidation in the animal health market is happening on two levels. Firstly, on a local scale, consolidation is a trend in veterinary practices. CVS and Pets at Home pioneered the change from private to corporate practice structure, and in the past few years there's been an increase in private equity-funded companies consolidating the market. But Mr Innes at CVS continues to see room for future M&A. Today's younger generation of vets is more likely to want to work for a corporation than their own practice, which means more private surgeries are coming up for sale. There's also enormous scope for consolidation in farm or equine veterinary practices and overseas. For example, in the US, the top three veterinary companies own just 10 per cent of the country's practices.
In veterinary pharmaceuticals, the biggest change in the industry is the acceleration of consolidation. Mergers and acquisitions among some of the bigger veterinary pharma groups are gaining serious traction. In 2015, US pharma giant Eli Lilly bought Novartis' animal health business for $5.4bn. Mars recently proposed to acquire VCA Antech, while Dechra made four large acquisitions in the past 18 months, taking it into the top 10 veterinary pharma companies by revenue.
IC VIEW:
With the animal health market both big and growing - not to mention relatively defensive to a potential decline in individual spending habits - we think it's an attractive area for investment. Acquisitions should accelerate growth in the companion animals market, while an increasingly carnivorous appetite has fostered a favourable outlook for farm specialists.
The UK plays host to a range of companies in the animal health space, but as these companies target different divisions of the market, it's hard to make a value argument for each and every one. According to broker N+1 Singer, the average forward PE ratio for the sector is 31.8 times, but this ranges from retail group Pets at Home to biotech specialist Benchmark.
Our recommendations are based on the companies we consider to have the best opportunity for growth in their respective areas of the market.
*10 March 2017: The original version of this article incorrectly referred to the Dechra chief executive as Ian Meneer. This has been updated.
