Animal healthcare a growing opportunity for investors

The large-cap pharmaceuticals sector, comprising some of the largest drugmakers in the world, has performed strongly over the last five years, rising 38% since 2014. Of course, its performance does not eclipse that of the S&P 500 or the Dow Jones Industrial index, both of which have been on an upward trajectory since 2009.

That said, the sector still demonstrates long-term growth potential as people grow older and wealthier and require more and more healthcare. According to the Deloitte 2019 global healthcare outlook, global healthcare spending is projected to grow at an annual rate of 5.4% in 2018-2022, a significant increase from 2.9% in 2013-2017.

However, there are a few red flags flying against this rosy backdrop. As governments try to manage healthcare costs downwards, the spectre of regulation looms large. They are using their clout as primary customers to force pricing lower, in the process impacting on profitability.

At the same time, generic companies are more prevalent and more efficient than ever before, and sales of older blockbuster drugs inevitably slow as cheaper generics become available. Generic manufacturers are also highly competitive, bringing cheaper products to market the moment they are off patent.

Lower risk

But these risks disappear when one talks about drugs for animals and livestock.

Organic growth potential in the sector exceeds that of human healthcare. There are two reasons for this, says Gerrit Smit, head of equity management at Stonehage Fleming. The first is that human consumption of protein is growing in excess of the world population as wealth increases, especially in emerging markets. Livestock and fish farming, and the treatment of those animals, benefit directly in this context.

The second is the changing role that pets play in human life. The same demographics that make healthcare attractive – ageing populations, rising middle classes and the delay in having a family – are trends that are supportive of animal healthcare.

“As wealth improves one sees a ‘humanisation’ of pets. For instance, in the US pets are referred to as companion animals, not pets. They are part of the family, and as such one doesn’t ask the vet what a certain drug or procedure costs,” Smit says.

Market intelligence agency Mintel estimates that people in the UK will spend £2.1 billion on pet care products and services, including toys and health check-ups, by 2023 – a 25% increase from an estimated £1.7 billion in 2018.

To accompany this growth, animal healthcare has other advantages over human healthcare, says Smit.

Less pressure on margins

First, there tends to be more brand loyalty and less generic competition than in human drugs. Additionally, the legal risks are much lower compared to human healthcare and there is also less pressure on margins and prices due to very little concentrated buying power – veterinary clinics simply don’t have the scale of national governments.

There are not many standalone investment opportunities in the sector, as animal healthcare is often a subsidiary of a larger pharma company. There are two stocks that Smit considers worth watching, and another that the firm is invested in. Worth watching is Elanco, which was spun out of Eli Lilly last year, and Brazilian firm Ouro Fino.

The stock that Stonehage Fleming is invested in via its Global Best Ideas Equity Fund, is Zoetis, the world’s largest producer of medicine and vaccinations for pets and livestock. It was a subsidiary of Pfizer until six years ago when Pfizer unbundled it to shareholders to unlock value.

In the last year, the company has embarked on a rally that has seen it rise 18.74% and is now up by 11.97% since the start of this year. This, after a gravity-defying +34.6% in 2017. The share has compounded by +24.4% per year since its IPO compared to the S&P 500 Index at +12.9% per year (US dollar terms).

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