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Is the animal health market still worth it?

The animal health market is undergoing a significant period of consolidation – but are growth prospects more fractured than ever?
September 6, 2018 Harriet Russell

A quick glance at general statistics from the pet population in the UK could lead you to believe that this is a growing – and buoyant – market perfectly suited for investment. Unfortunately, the true picture is far more complicated. As several animal health-focused companies have struggled this year, it’s important to interrogate the wider implication of consolidation across the sector, as well as different opportunities in the market, such as pharmaceuticals versus retail.

The Pet Food Manufacturer’s Association (PFMA) estimates around 45 per cent of British households own a pet, with nearly a quarter owning a dog and a fifth owning a cat. Meanwhile, working with statistical poll expert YouGov, veterinary charity The People's Dispensary for Sick Animals (PDSA) found that a fifth of dog owners reckoned they could spend between £5,000 and £10,000 on their pet during its lifetime, with 23 per cent believing the monthly cost to be around £81. The statistics are similarly sunny in the agriculture market, where rising global populations are putting more pressure on farmers to churn out high-quality meat and fish, all with the help of veterinary pharmaceuticals and nutrition products.

 

 

Whether a retailer selling pet food and accessories or a pharmaceutical company developing medicines for sick animals and the farming industry, these figures suggest there’s a ripe and ready market. But other numbers complicate the story. According to statistics portal Statista, the estimated pet population in the UK has actually fallen from a high of 71m in 2013 to 51m in 2018, with each year in between showing steady decline. Meanwhile, the global cattle population rose to a peak of 1bn in 2014 and has remained resolutely stationary ever since. And yet, spending on animal health products in the western world has never been higher.

The stats suggest that people are owning fewer animals but are willing to spend more on them, which begs the question: has pet ownership just become more expensive in a top-down sense, rather than pet owners actually lavishing more attention and pampering on their animals? Either way, it seems there’s more at stake for companies involved in the animal care sector. Investors should be wary of the pitfalls as they seek opportunities from a market that appears to be in growth mode.

 

 

Consolidation conundrum

For veterinary practice owners and their pharmaceutical suppliers one of the main obstacles to continued growth is market consolidation. The UK’s veterinary market is in the midst of significant transformation, driven by a lack of independent purchasers for practices which have become available as the current owner retires. At the end of 2017, around 30 per cent of practices were owned by corporates and this is expected to rise to 50 per cent by the end of 2018 and 70 per cent within five years. CVS (CVSG) is a case in point. When it was extracted from private equity in 2004 it had just 12 surgeries. Today, it owns 482 clinics and referral centres across the UK, 21 in the Netherlands and three in the Republic of Ireland.

But unfortunately for CVS, it's not alone when it comes to the attraction of the corporate veterinary practice model. Private equity has been increasingly active in this market, as have competitors including Pets at Home (PETS). As a result, vet practices are commanding far higher prices and CVS and its peers are having to dig deep into their pockets to keep up the acquisition pace.

It’s a similar trend in the US which, although a considerably larger market than the UK (with more than 27,000 small animal practices), is currently much more fractured. In 2017, the top three chains represented less than 10 per cent of the total market. But change is afoot. Three massive deals have completed in the last four years, including Mars Inc’s $7.7bn (£6bn) acquisition of VCA.  

All of this M&A has created challenges for those pharmaceutical companies providing medicine and devices to practices; when vets merge, their customer register is trimmed. Management at the UK’s largest veterinary pharma group, Dechra Pharmaceuticals (DPH) admitted that in the US the group now relies on just a handful of very large customers. This might mean fewer costs to service the bigger accounts, but it also ups the pressure on Dechra to keep those customers happy, while more aggressive discounting could end up hurting margins. 

Market pressure may have been the motivation behind Eli Lilly’s decision to spin out its animal division – Elanco – into a separate company earlier this year. Or the catalyst for Animalcare’s (ANCR) £2.65m sale of its wholesale division. The beleaguered UK group has struggled since its reverse takeover of Dutch veterinary group EcuPhar last year and outgoing chief executive Chris Cardon (the second boss to leave in the last year) said the sale would allow the group to focus on its higher margin veterinary pharmaceuticals business.

 

Getting it right with genetics

But while veterinary drug distribution has become a challenging market, demand for new pharmaceutical products continues to soar in both the companion animal and farming industries. Zoetis (US:ZTS) – the world’s largest veterinary pharma company – has enjoyed a 43 per cent share price rise in the last 12 months, thanks to strong demand, while the animal health divisions at Merck (US:MRK) and Bayer (DE:BAYN) both reported solid growth in their most recent half-year results.

But in the UK, opportunities for investment in novel animal drug developers remains limited. Eco Animal Health (EAH) is the nation’s only 'pure-play' developer, but its reliance on a single product has spooked investors. After a whopping 110 per cent share price rise through 2016 and 2017, sentiment has stalled this year despite continued strong demand for the group’s main product Aivlosin. Management insists that internal product development and acquisitions will enhance growth opportunities, but a forward price/earnings rating of 25 times looks steep for a company with just one product.

Instead, investors should look to the UK genetics space which is benefiting from a strong demand across the farming sector. Genus (GNS) and Benchmark (BMK) – both of which supply genetically enhanced animals to global agriculture customers – have enjoyed double-digit share price growth in the last 12 months as worldwide population growth increases the need for efficient animal production.

It hasn’t always been an easy ride. A weak agricultural market hampered growth in this part of the sector between 2013 and 2017: Genus suffered due to poor milk and pork prices, while Benchmark was held back by an uncertain regulatory environment in Chile and meteorological events affecting fish farming. But now, both companies are in high demand. Genus has seen good demand for its new semen sexing technology which increases the chances of female dairy cow births. It's expected to be popular in India, where religious laws ban the slaughter of male calves. Meanwhile, Benchmark has recently completed the development of its Norwegian facility which can deliver disease-free fish eggs all year round.

 

Commercial challenges

The recent trajectory of shares in Pets at Home and CVS suggests the commercial end of the market is structurally weak. In the former’s case, the landscape of pet retail has changed irrevocably over the last few years, transitioning largely online and at competitive discounts. It’s left companies rooted to the UK high street floundering, as bigger chunks are taken out of margins to keep up with rivals. Over the last 18 months, bosses at Pets at Home have halved the price gap with peers, and only opened one superstore against a projected five.

Pet’s vet business is also growing, but at what cost? Vet group revenue increased 18.4 per cent to £32.4m during the first quarter, including joint-venture vet practice income up 19.9 per cent to £19.4m. Older vet practices are growing ahead of the market and younger vet practices are growing in line with management’s expectations, but analysts at Liberum urged investors not to ignore the £20m working capital outflow which supported this growth, along with a market shortage of available vet practitioners.

These concerns have been echoed by vet owner CVS, which admitted recent trading in some of its newly acquired practices was disappointing. An aggressive acquisition strategy, which saw the group spend £51m on 52 new surgeries during its last financial year made it the largest owner of veterinary practices in the UK. But staff costs are on the rise, and investors shouldn’t be too quick to forget the group’s profit warning last December, either.