Zoetis : William Blair 44th Annual Growth Stock Conference (Transcript)

Company Name: Zoetis Inc. (ZTS)

Event: William Blair Growth Stock Conference

Date: June 4, 2024

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My name is Brandon Vazquez, I am the covering analyst of Zoetis at William Blair. I'm required to tell you to go to williamblair.com for a full list of disclosures and conflicts of interest for the firm.

And we are excited today to have with us from Zoetis, Wetteny Joseph, the CFO. He is going to run us through somewhat of a brief overview of the company, and then we're going to do a fireside chat, talking some high-level takeaways and we'll maybe go a little more granular in the breakout after.

But with that, I'll let Wetteny take it away.

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All right. Thanks, Brandon. Look, for those who may be relatively new to Zoetis or the animal health industry, I'll just spend a few minutes. I won't take too much of the Q&A time. Just to give you some highlights around our industry and who we are. We are the market leader in a very resilient industry.

Our industry has very attractive end markets that have been driven and continue to be driven by a growing world population that is looking for increase in demand for animal proteins that drives our livestock business. And then a human animal bond that has been elevating for several decades now.

The importance of pet health, not only in the Western world, in the U.S. and Western Europe, but around the world. The industry has had and demonstrated an ability to consistently drive stable growth and in fact, has grown about 5% since 2013, if you look at the CAGR for the industry. This is an industry that has proven to be recession-resistant being able to grow even in some tougher economic conditions, including the great recession, where the industry grew about 2% to 3%.

Now Zoetis has repeatedly outperformed that industry growing about 8% since 2013, which is effectively 3 full percentage points above the market. Our purpose as a company is to nurture our world and human kind by advancing care for animals. We want to be the most trusted and valued animal health company driven by innovation, our customer obsession as well as our purpose- driven colleagues.

Now on this page, you can see at a glance that we delivered $8.5 billion in revenues in 2023, which is spread about two-thirds companion animal globally and about one-third livestock. Our products are sold in over 100 countries with about eight core animal species and seven major

product categories. We have more than 70 years of experience in our industry, with 14,000 colleagues that are really at the core of who we are.

Briefly, I'll highlight a few differences that make animal health unique when you compare it to human health. We have faster time to market and less technical risks in R&D. Our drugs get to market faster and more economically. We have very limited third-party payor dynamics. In fact, the veterinarian is the key decision-maker and not insurance companies compared to human health. And because of this, you've seen very limited impact from generics in our industry.

And in fact, our brands continue to drive growth and profits decades after patent expiry. And Zoetis has also demonstrated strong financial leadership and strong financial management, which makes us a high quality growth stock as well. We are a leader in all of the markets that we compete in. We are also the innovative leader in our space, and we are very diversified with multiple sources of growth and our sound investment decisions have been driving high ROIC for the business. And we've demonstrated an ability to consistently not only drive growth but also return capital to our shareholders via our dividend as well as share buybacks.

With that, I will come back and Brandon and then we can go through Q&A.

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Great. Yeah. Thank you for that overview, Wetteny. Let's start on the companion animal side, and we'll start. You mentioned many of the points that I wanted to hit on, but let's try to get a little more granular on them. One of them that you discussed was that you guys have outperformed the broad animal health market, which is already in a pretty healthy robust market by about 3 points. What is it about Zoetis that allows you to consistently do this? I think the last time you disclosed that it was almost a decade that you've been outperforming the market.

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Yeah. Look, I think it starts with our purpose-driven colleagues and the fact that we are fully engaged with our customers on a regular basis across the company. Of course, we have our field force to do that day in and day out, but all the way through our leadership teams and executive team, we are constantly in contact with customers.

And what we try to do is to compete for that customer to be the first to meet their unmet needs and do it with products that are high-quality products with the safety profile and efficacy that we're looking for. And so we start with that and in mind from the very beginning. And we pursue areas that are going to be areas for us to drive and develop a market and avoid having programs or projects that are just interesting science projects, if you will.

And so our commercial teams are engaged from the very beginning in terms of identifying and helping to drive those markets. We then have a disciplined approach in terms of R&D. And our innovation, by the way, does not stop in R&D. It's beyond R&D in terms of our ability to then scale those areas, and we marry up R&D and manufacturing early enough so that we can make sure that when the products come out of R&D, we can scale them and deliver them at a price

point that a cash payor generally can afford as well and then commercially, we hand those solutions back in their hands to expand the market, educating pet owners, educating veterinarians and driving the market to be much bigger than it was when we came into it.

So if you take dermatology, for example, which is one of our biggest franchises, we delivered over $1.4 billion of revenues in dermatology last year when our first product launched back 10, 11 years ago, Apoquel the market, and our expectation was something along the lines of $100 million or so.

And so this is just continuing to do that, and we still see opportunity to grow that market even today, not only in the U.S., where there's still $7 million that should be treated that are either not treated or undertreated but outside the U.S., where the markets they even longer to get to their peak sales, we see a tremendous opportunity to continue to do that. So I think what I've come to appreciate in the three years I've been with the company is that combination of driving innovation through not just R&D, but commercial execution and scaling and manufacturing, having all three come together is what's driven our success.

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Okay. And now that you have a companion animal business that's $6 billion law of large numbers catches up to everybody at some point. But you guys have reiterated last year at your Investor Day that you can grow mid to high-single digits pretty durably. What is it? Is there anything that changes in the playbook as the business gets larger? Or is it simply a doubling down of what you guys are already good at?

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Look, I think there are so many unmet needs still in our space despite our success and what you've seen from the industry over the last decade or so that we still see significant opportunity to drive the business from here, not only in our current existing franchises and our core products, where we continue to see opportunity to grow.

You take parasiticides, for example, that's a $6 billion, $6.5 billion global market to begin with. And Simparica Trio is the latest standard of care in terms of triple combination products. But you still have almost half of the units, I'll call in terms of number of pets still are treated with collars or topical. Well, Triple combinations are a higher price point, so that drives more than 50% of the market.

But there's still a tremendous opportunity to continue to drive that into the market and continue to grow it. And so dermatology, I just spoke about, so I won't repeat that. We are very excited about our osteoarthritis pain products, which in companion animal compared to livestock, the animals are living a lot longer.

So they develop diseases like osteoarthritis pain and so on. We're just in the early innings, if you will, three years or so outside the U.S. within the first six, eight months of launching in the U.S.,

and we're very excited about the opportunity here to build yet another $1 billion franchise in osteoarthritis pain that will be driving our growth over the next few years.

And on top of that, we have significant lifecycle innovation that we're investing in to continue to drive these markets and then net new markets that we're going after, which we talked about during Investor Day last year, those include renal, oncology, cardiology, et cetera. If you look at chronic kidney disease, I had the opportunity to go and visit with some veterinarians at the end of last year.

And one vet in particular, clearly said, this is one of the most frustrating areas for them to deal with and their practice is chronic kidney disease, particularly on the cat side, but also on the dog side. So lots of significant opportunity yet to go after, which is why we're confident in our ability to continue to drive mid to high-single digit growth in the business.

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Okay. And on just so that we hit livestock at some point or I'll forget to bring it up, but livestock is about a third of your revenues today. Lower growth business, but one that you guys remain dedicated to. Just talk a little bit about what are the dynamics there? Why is it a little bit lower growth? And why do you remain committed to despite it being a little lower growth and lower margins?

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Yeah. Look, livestock is an attractive market. It's about a third of our revenues globally. If you look at where livestock is today, it's a business that grows about 2% to 4% globally in terms of the industry. And if you look at how we've gotten here, significant productivity that we've been able to drive in livestock over the years.

The demand for livestock for animal protein continues to be strong across the world, particularly across the emerging markets. So if you look at population growth, we're expecting to see another 2 billion people on this planet within the next, call it, just under 30 years and the need to continue to drive healthy animal protein is something that's going to drive that across markets, emerging markets, we're seeing a growing middle class and income levels going up, they are looking to have access more to, again, healthy animal protein that's driving the consistently driving that growth.

Now there's still significant opportunities here. For us, it's continuing to invest in vaccines as preventative solutions to keep animals healthy and more productive. We have immunotherapies that we're pursuing in terms of our R&D pipeline to drive alternatives to antibiotic use. We have effective vaccines and poultry and so on. So we're very excited about the opportunity to continue to drive this business. And there are significant areas of leveraging the same skill set in R&D in terms of understanding the species and the disease space and the biology, et cetera, that we're able to leverage here.

So we do believe that we are the rightful owners for our livestock business, and we'll continue to invest in it to drive it and also drives significant return on invested capital for us. So we're big on livestock will continue to be.

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Okay. And now going back to companion animal, I think in our breakout session, maybe we'll get a little more granular on upcoming competition. But generally speaking, in Zoetis' history, this is a competitive space. How have - what levers do you guys have at Zoetis to defend market share as new competitive entrants come in the market? Talk to us a little bit about you've clearly had competition in main product lines throughout your history, what do you do in order to defend there?

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Yeah. Look, the first thing that I look at when it comes to competition is we tend to be in front of the market in terms of new innovation. And that gives us years of experience with veterinarians and pet owners and satisfaction levels that are really high for our products. So if you look at, for example, Apoquel, which has been in the market for over 10 years, approaching 11 years. The satisfaction level for Apoquel in terms of efficacy is like 95% among veterinarians. And so that's

• to me, that's the first point.

And then the second one is, I look at opportunities to be offensive before I look at defensive. And so those markets continue to have opportunity to continue to expand them. As I said earlier, there's still about 7 million dogs in the U.S. that are undertreated or not treated at all that we can go after outside the U.S. even more.

And what we find is particularly when you have a product that's been in the market for years and the efficacy and safety record is there, there's very little sort of switching that happens in our space if someone is not coming out with meaningful differentiation. And I stress that were meaningful because there's nuance things you can argue, you can say that's differentiated. But the reality is it has to be very meaningful to overtake a decade worth of sort of history in terms of efficacy and safety and highly satisfied customers. So those are the things that we do.

And then the last thing I would make is, look, we are investing north of $650 million in R&D and driving these franchises to continue to innovate in them. And as the market leader in dermatology as a market leader in many of the markets that we operate in, we're not seeing any market to anyone. We'll continue to drive innovation in those spaces and defend them as well.

And you've seen that play out, for example, with Simparica Trio. Trio has been out for - since April 2020, we had about a 3.5-year head start before the next player came in the U.S. that is with a triple combination. And since then, three quarters straight, we're posting increases in our market share, patient share with Trio with head-to-head competition in that space. Again, these are the type of things that will continue to drive with the business.

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Okay. And maybe last high level, we should touch on the P&L a little bit. You guys have done a great - you've had some - at your Investor Day, you also talked about this over the years. You've grown your operating margins to high 30%. I think we're calling at 38%, roughly around there today.

But one question we often get is if you - what's the algorithm for EPS growth from here, are you topped out at operating margin growth essentially at this point, given it's already very strong. So talk to us a little bit about the algorithm, what opportunity is there left in this P&L in the long- term for margin expansion?

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Look, we see significant opportunity. If you look at companion animal because they live longer, there are lots more opportunities to go and have meaningful innovation in those spaces. And we see the secular tailwinds for companion animal being even faster than livestock that we've seen over the years, and we see that continuing.

So while companion animal is about two-thirds of the business today, in the U.S., it's approaching 80% of the business. And outside the U.S. just in the time that I've been with Zoetis in the three years, we went from companion animal being just under 50% in the international business to be in just over 50% across international. So the rest of the world is moving in the direction that the U.S. has, which more companion animal, which has a higher margin profile than livestock.

So just that mix alone is going to drive it. And then the innovation that we're driving with the MAbs for OA pain and other areas, oncology, renal, et cetera, that I described earlier, all in the companion animal space. Now we are also innovating in livestock, as I mentioned, but these areas are going to continue to outpace that growth and that mix will continue to contribute towards expansion of gross margins, and we're able to leverage our scale in terms of - we see it in the guidance that we gave this year. We're leveraging SG&A spend significantly in driving margin expansion in the current year. We think there's more opportunity to continue to do that going forward.

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Okay. Maybe a little bit more recent events, maybe somewhat high level still, but recent events. A lot of us look at vet visit volumes in the space. It's something that's been compressed ever since what have been seemingly difficult comps in the big COVID puppy booms in 2020 and 2021. I guess, the first question is - what do you guys think is happening here from your view? You obviously have good also in the companion animal market. Why are we going into our third year of decelerating vet visits here and then the follow-up is how do you consistently continue to outperform that, right? Your stock kind of trades off into the quarter as everyone gets vet visit volumes, you do better, and then we do it again next quarter. What is it that you're doing that's allowing you to outperform

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Well, the one thing we've consistently done is even in the face of decreasing overall vet clinic visits, you're seeing us posting growth rates, not just in price, but volume growth in the U.S. And so at some point, I'd like to see that be perhaps better recognize and see - and we think there are some real important reasons. If you double-click on vet visits, what you see is therapeutic visits that continue to grow. You're not seeing declines in therapeutic visits. Our business is more tied to therapeutics, right, versus wellness visits that might see some headwind. There's not much outside of diagnostics a bit of wellness visits that we're tied to. So that tends to drive our business more than the overall number. So you have to double click and see what's happening with therapeutics overall.

The second thing is you have alternative channels that are increasing proportion of our business. So whether you look at retail, online, brick-and-mortar, et cetera, those have been outpacing the overall growth. So since 2019, where these alternative channels were about 5% of our companion animal business. Companion animal has grown significantly since then. And yet, we're now at about 13% of our business going through those channels despite the massive growth you've seen in companion animal.

So it's outpacing. I mean it's been growing in the 25% to 35% range almost every quarter since I joined the company. And those are not really reflected in those vet visit numbers, although you do require a veterinary prescription to get those products, they're just not fully reflective in those visits. So I think the combination of those two things is why you continue to see us drive growth despite some headwind in terms of overall visits even though therapeutics visits remains strong.

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Okay. Do you have any sense of when wellness visits may turn back around and also support that?

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Look, I'm not going to completely speculate on. I do think the core of this is not an end market demand challenge as much as it is capacity in the vet clinic. So if you have to pick and choose between a chronic condition with a particular animal versus a wellness visit, you're going to bring in the one that has a chronic condition. And so we see that playing out. If you look at how long it takes to get an appointment into a clinic, et cetera. I had the opportunity to sit down with a very senior person from a large corporate organization that own thousands of clinics around the U.S.

And in 2023, when overall business were down about 1%, 1.5%, they were up 2.5%. And the reason was because they have a formula for making sure that the veterinarian has what they call 65% of their time, hands on the animal. And so they're really scheduling and staffing in a way to enable the vet to do that. And by doing so, they will to get more throughput through the clinic, and they saw that 2.5% increase through November of 2023.

So I think this is clearly demonstrating that the underlying demand is there even with wellness visits, I would say, although clearly, it could be sometimes when someone would delay visit or what have you, and it's more difficult to get an appointment. But overall, the demand profile is very healthy in the U.S. And of course, most of the markets that we're looking at.

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Okay. And let's maybe spend a couple of minutes on Q1 specifically, since Q1 was a good strong quarter for you guys ahead of expectations. I'm going to lead the question a little bit here, but what was most telling to us contrary to 2023 was the companion animal drove the biggest part of the beat rather than livestock. You had that kind of flip that was encouraging. What is - what are you seeing in companion animal that was so strong - and which segments would you call out there? And what does that mean for the rest of the year in those specific segments?

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Look, I think there are a number of areas that were really strong, and there was an outstanding quarter, 12% operational growth on the quarter. Now as you said, last year Q1, we had a very robust livestock quarter, 12%. So we're up against that comp. And so the mix is different where companion animal had a softer comp because of some destocking in the prior year. When we neutralize those, you still have a very high single-digit growth in companion animal globally in the U.S. double-digit growth for companion animals.

So really, if you look at the performance with dermatology, they grew 25% globally. That's a big driver. Trio, as I mentioned earlier, head-to-head competition for triple combination and Trio was 61% in the U.S., 58% outside the U.S. as well. So globally, Trio grew - was outstanding quarter. And then our OA pain franchise delivering $130 million of revenue with Librela, having $100 million of that $40 million - just over $40 million in the U.S., $60 million outside the U.S., 189% growth even if you take the U.S. out of that mix and the national grew 70%-something.

So I think those could be areas where the biggest drivers to the growth that we saw. And we raised guidance after just one quarter, which is really signaling our confidence and continued momentum into the second quarter from what we saw in the first quarter. So we couldn't be more pleased with the performance in the first quarter and pleased to be able in a position to raise guidance.

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Okay. And on those - so you have those three buckets and granted, yes, there was easy comps year-over-year, but still really good momentum and ahead of expectations. To be clear, it doesn't sound like there was any kind of bulk ordering or anything like that going on there. This is seems like there's pretty solid momentum, which is what gave you confidence in part to raise guidance for the full year on the organic growth side.

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Yes, that's right. I mean if you look at - we're still launching the product Librela in the U.S. So clearly, that's continuing to ramp. There's very little to no stocking in number, as we said, because we had such high penetration in the fourth quarter, north of 60%. The incremental percentage you get to 70% isn't enough to move the needle from a stocking perspective. So no stocking to speak of. And overall, if you look at stocking across distribution channels, they've been in relative terms towards the low end of the range since Q1 last year. We haven't seen any movement there. So really strong underlying demand right through to the end customer is what we're seeing across the business there.

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Okay. And maybe let's spend a minute on Librela, because this is such a key part of the growth story in the next three to five years, probably right, your next $1 billion franchise when we do kind of our surveys and we talk to any vets, this is a great product, and we find a lot of good customer reviews. But of course, there's been negative headlines. This isn't a secret, whether it's Wall Street Journal or other media outlets. Where are you guys hearing from vets? I think at the end of the day, the vet seemed to be the most important person recommending this, right? Our vets seeing any of this noise and are they taking a step back at all? Or talk to us about what you're seeing from the vets, given the noise that we're hearing.

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Yes. The short answer is, no. Vets are not stepping back at all in terms of their intent to use the product or prescribe their product, et cetera. And look, you can see it in our numbers in terms of the growth that you see Librela in the U.S. This is why we took the time to share the data point around if you look at a rolling four-week basis, through April when we gave guidance and through May now, as Kristin talked about last week, we continue to see a steady increase in demand for Librela in the U.S.

Now we're well past the headlines in terms of some of the misinformation that we've seen here. So we're very pleased with that. But to your point, it is the vet that is at the core of this, and that's the center of this, right? The veterinarian is able to understand the science and the data. And as we've been very transparent with them, we have doubled down on making sure they're educated on those facts.

They're able to have the right conversation with the pet owner. By the way, whose trust they have for caring for that animal probably for some time before this to be able to articulate why they still believe this is the right solution for a dog that's suffering from a [indiscernible] (0:24:58) and continue to drive the demand that we've seen and we continue to see through the month of May here. So we're very pleased with that. We've done survey after survey gauging that, by the way, by veterinarians up until within the last couple of weeks, even we continue to see consistent intention to prescribe the product and use it. And again, we're seeing in the revenues as well.

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Okay. Great. And maybe one last one on Librela, is basically, as we think in the future, for this to be a $1 billion franchise, what needs to happen commercially? What levels of penetration do you think you guys need to see in order for this to reach that potential.

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Look, as we said during Investor Day, the combination of Librela and Solensia, we expect to be north of $1 billion in revenues in the, what I call, the initial peak sales because these are areas that will continue to grow. Our initial peak sales expectations for Apoquel is something like $100 million or so initially.

So we're at $1.4 billion. So clearly, there are opportunities to continue to expand those markets. And what needs to happen is actually what's actually happening already. So let me give you a few data points. As I said, this first quarter was $131 million or so of revenue between those two products in a quarter. And if you look at what's happening outside the U.S. in international markets have been around for just over three years.

We're already seeing the penetration of Librela, well into moderate and mild cases. And so the latest surveys we've done across European veterinary practices indicates that over 50% of the dose they're shooting with Librela now are moderate cases. And then some additional percentage mild cases. So now the majority are between moderate and mild, which is important in terms of those that are going to be on muscle therapy going to continue to increase, which are now between 7 and 8 months.

These are the elements that we factored into our thinking around the size of the opportunity, and we continue to see a climb in terms of - and now these are first line of treatment. For veterinarians around OA pain, et cetera, all the dynamics that we expected to see we are seeing there. Now the U.S. is still relatively early. But as I said, the intent to prescribe and the data and the ordering that we're seeing continue to support this, and we remain very confident in our ability to get these franchise to that $1 billion-plus range in the three to five-year from what we said.

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Great. With the last two minutes here, I think one question following last quarter. You did raise the organic guidance range. I think by about 1.75 points. I have gotten a lot of questions around how much of that is price? How much of that is volume? Maybe just walk us through so that we can all level set in that increased guidance, how much of it basically is coming from volume versus price.

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Look, we didn't get to that level of specificity around the guidance. I think given the strength we see in the business and the results, you saw 12% operational growth when we gave guidance of 7% to 9% to start the year. And continued momentum that we saw, we raised guidance is just after 1 quarter, and we continue to drive the business in that direction. So we're very happy to be