Investors are Growling for Animal Health Stocks

By Linda McDonough

Animal spirits are alive and well in the veterinary sector.  Recent speculation that Valeant Pharmaceuticals International (NYSE: VRX) would bid for animal vaccine and medicine maker Zoetis (NYSE: ZTS)  is not surprising based on the rapid consolidation in the animal health sector seen over the last year.

Although there are fewer independent names left in this industry, we’ve uncovered a few meaty bones that offer exposure to this highly profitable sector. IDEXX Laboratories (Nasdaq: IDXX), the kingpin in diagnostic veterinary tests, and our very own Roadrunner stock, VCA Inc. (Nasdaq: WOOF), both offer investors a tasty treat.

Zoetis was spun out of Pfizer (NYSE: PFE) in 2013 to allow Pfizer to focus solely on its pharmaceutical business. Since that time, the stock has risen 55% despite a dramatic slowdown in its revenue. Unlike Pfizer most other medical conglomerates have turned on their tails and begun buying up animal health stocks in order to capitalize on higher growth and more attractive margins.

Companies in the drug and diagnostic area are keen to diversify their medical operations, whose profits are increasingly getting squeezed by health insurers, into the sale of veterinary products, which are paid for out of pocket and are less susceptible to generic competition. In addition, drugs and diagnostic products for animals are not subject to lengthy FDA reviews, allowing companies to turn around animal research dollars much faster than those allocated to human drug development.

The recent acquisition spree began in April 2014 when Eli Lilly (NYSE: LLY) agreed to acquire Novartis Animal Health for $5.4 billion, valuing the company at a very-pricey 28 times EBITDA. In January of this year, AmerisourceBergen (NYSE: ABC) agred to purchase MWI Veterinary Supply for $2.5 billion,  or 21 times EBITDA.  Less than six months later, Patterson Companies (Nasdaq: PDCO) bought Animal Health International for $1.1 billion or roughly 17 times EBITDA. All three targets are distributors of veterinary products and produce similar profit margins.

Although IDEXX Labs trades at 18 times EBITDA, its business of selling diagnostic blood tests to vets is more than 5 times as profitable as MWI and Animal Health. This level of profitability comes as no surprise to this pet owner who gasped at the $400 charge for routine Idexx blood tests done on her Basset Hound during an annual visit to the vet. A recent weak quarter due to the transitioning of some distribution channels put Idexx in the dog house.  Its stock is down 15% year to date but this bump in the numbers is likely temporary.  Idexx’s high level of profitability and above average 8% revenue growth make this a thoroughbred investment.

VCA has been discussed at great length in the Roadrunner Momentum portfolio but continues to demonstrate purebred growth.  In the most recent quarter, revenue grew 11%, an acceleration from the company’s 2014 annual growth rate. As a service provider, VCA is slightly less profitable than Idexx but its valuation of 13 times EBITDA reflects those numbers.

As the medical industry continues to froth at the mouth for above-average growth and profitability, these two stocks will leave investors purring.  Even without getting “adopted” by larger conglomerates, IDEXX and VCA are excellent companions for any portfolio.

Around the Roadrunner Portfolios

GIII Apparel (Nasdaq: GIII). “Simply put, regardless of the direction the wind is blowing, at G-III, we get the job done”.  Morris Goldfarb, President and CEO of G-III Apparel, pretty much nails it in the first-quarter conference call when describing the company’s performance as of late.

While many retailers are blaming poor weather or tight purse strings on their lackluster results, G-III is delivery incredible results.  The designer, manufacturer and marketer of licensed apparel has diversified its business so well, that it does, in fact, get the job done regardless of the cross-winds blowing against the retail industry.

In the first quarter, reported on June 3rd, the company grew revenue 20% and increased its forecast for annual earnings to $2.71 up from a previous estimate of $2.58 representing 20% growth. Despite being its largest brand, the company’s Calvin Klein business continues to grow.

Part of G-III’s recent success has been its keen focus on dresses, the one bright spot in women’s apparel. Geometric print maxi dresses by its Eliza J. brand have been jumping off the racks at Nordstrom.  Floral Vince Caputo swing dresses were all the rage at Macy’s. Management noted that Eliza J. has become the number one dress brand at Nordstrom, quite an accomplishment when considering the portfolio of brands Nordstrom’s has at its disposal. The Eliza J. business doubled in the most recent quarter.

Luckily for G-III it is not dependent on any one brand or traffic to any one department store. Although almost 60% of its sales are to department stores, only Macy’s accounts for more than 10%.

In addition to expanding the licenses for which it develops product, G-III grows its revenue by gaining space on the floor of retailers.  In January, premier brand Jones NY announced that it would shutter its wholesale business.  This leaves G-III the opportunity to grab that retail space and fill it with racks of Calvin Klein sweaters and Tommy Hilfiger jackets.

Like your favorite jeans, it’s hard to let go of G-III which has been a fabulous pick for Roadrunner Stocks. The stock is up 240% since our May 2013 inclusion.  Yet with ever increasing estimates, the stock still fits quite well.

Marcus & Millichap (NYSE: MMI) has certainly earned its place in the Roadrunner Momentum portfolio. The stock is up 97% since its August 2014 inclusion and shows no sign of slowing down.  

The commercial real estate broker more than doubled earnings per share in its most-recent first quarter to 35 cents. Earnings for the year are expected to equal $1.65 for the year ending December.

The company, who championed exclusive listings for commercial properties way back in 1971, continues to reap the benefits of its well trained team of brokers. The company notes that the commercial real estate recovery, which had originally been concentrated in the East and West coasts in 2012, has spread to all major metros in the country.

Just as George Marcus explained to his inaugural team of inexperienced brokers in 1971, the real estate business is about providing honest value to customers. Once you have a handful of happy customers, referrals will grow the business for you.  Certainly that’s a simplification of the work done by Marcus and Millichap’s to extend its real estate portfolio from hotels to apartment buildings blanketing the country.

The company has close to 3,000 properties listed on its website ranging from a $50 million hotel at the foot of the Lincoln Tunnel to a $30 million self-storage facility in Seattle Washington.

Management is ebullient about the business going forward.  The dearth of new retail properties built over the past 5 years will continue to feed the secondary market. Demand for commercial restaurant properties continues to track the rise in demand from millennials who are eating out more than ever. As Senior Executive Vice President Hessam Nadji so accurately describes, there has been very little supply of new commercial properties since the recession.  As the commercial broker scoring an abundance of these properties, Marcus and Millichap looks right at home as a momentum stock.

Paycom Software (Nasdaq: PAYC). With only two months under its belt in the Roadrunner Momentum portfolio, Paycom Software is already a big winner. The stock is up 5% since our April 29th inclusion. Although the stock is expensive utilizing traditional valuation tools, its tie to a secular change in human resource regulations should keep that valuation afloat.

For years, human resource departments have employed software to manage and organize the oodles of data fed to them.  There is no shortage of products for a recruiting team to help find and screen applicants. The same can be said for payroll packages that track hours, salaries and taxes. There is also sufficient supply of software to coordinate and execute the knotty regulations of employee benefits.  

However, after buying these various and often discordant products, companies found themselves spending huge amounts of time tying the information from various software packages together. Paycom is one of the few companies that unifies talent acquisition, time and labor management, payroll, benefits and talent management in a single subscription product.

Human resources is one industry where a subscription model makes much more sense than purchasing a software bundle.  In a sector where tax rules and regulations are continually changing, updates to tax rates, healthcare savings account rules and mandated coverage guidelines are updated continuously.  

Obamacare has been and will continue to be a driving force for Paycom’s growth.  Any company with more than 50 employees finds itself up against a January 2016 deadline to meet various Affordable Care Act requirements or paying a fine.  

Paycom just released an updated Affordable Care Act compliance product.  According to the company, two thirds of companies are not ready to comply with the January 31, 2016 Obamacare deadline.  Paycom’s software allows companies to free up resources to manage other aspects of their business and to remove human error from manual input of critical data.

The company grew revenue 49% in the first quarter and expects annual revenue growth to be 35%. Earnings per share were 11 cents up from 2 cents the previous year. Profits should start to reap the benefits of ten new sales offices that have opened in the past 2 years. Management notes a drag in productivity in new offices until they mature 24 months later.

A secondary offering in May reduced private equity firm Welsh, Carson and Stowe’s position by almost one third. This is a common exit strategy for a private equity firm to reduce their position once an investment becomes public and not necessarily a red flag to investors. Additional secondary offerings may be announced in the future.  The CEO, who also sold on the deal, continues to hold 19% of the company shares.

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