So far, 2024 has been a year to forget for animal healthcare juggernaut Zoetis (ZTS -0.56%). Hit by the triple whammy of weak earnings, a formal investigation from the European Commission, and adverse events linked to some of its newest medicines, Zoetis has seen its share price plunge 27% this year and 40% from its all-time highs.
We will get to these issues in a moment, but the silver lining to these recent developments is that Zoetis shares now trade at a once-in-a-decade valuation. So this begs the question: Is Zoetis now a fundamentally flawed business destined to continue dropping? Or is this sell-off a unique opportunity for investors willing to buy and hold for a decade and beyond?
Here's why I'm leaning toward the latter.
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Is Zoetis stock losing its bite?
Zoetis is the global leader in medicines, diagnostics, vaccines, and beyond for the companion animal (cats and dogs) and livestock (cattle, swine, horses, fish, and sheep) markets. Selling in over 100 countries, Zoetis is the global market share leader (by species) in categories that comprise over 90% of its total sales.
This dominant positioning in the animal healthcare industry has helped the company deliver total returns of over 400% since its 2013 spinoff from Pfizer. However, after outpacing the returns of the S&P 500 index for more than a decade, Zoetis stock has struggled recently after three red flags appeared.
Missed earnings and disappointing guidance
Despite growing earnings per share (EPS) by 15% in the fourth quarter, Zoetis missed analysts' EPS estimates by $0.08. Making matters worse, the company also guided for 2024 EPS slightly below analysts' expectations.
As disappointing as these shorter-term figures were, 2023 marked the company's 11th consecutive year of growing faster than the animal health industry. The power of this longer-term trend is far more helpful in analyzing the strength of Zoetis' operations than what analysts may expect over any given 90-day period.
With the animal healthcare market expected to grow by a 5% clip annually through 2032, there should be no shortage of growth in the company's immediate future.
An investigation by the European Commission
In March, the European Commission opened an investigation to determine whether Zoetis breached some of the European Union's competition rules. Regarding the company's Librela osteoarthritis medicine for dogs, the investigation will consider whether Zoetis acquired a peer with a similar product only to shut it down shortly after. Zoetis has replied that it is confident "any potential concerns are unfounded."
Regardless of how this investigation pans out, it shouldn't prove to be a thesis-breaking development for Zoetis investors. Home to 15 blockbuster drugs generating over $100 million in annual sales -- across 300 product lines -- Zoetis is well-diversified and not at risk of crumbling over any single medicine.
Osteoarthritis medicines' adverse events
Meanwhile, Zoetis shares were hit by a report in The Wall Street Journal that the European Medicines Agency (EMA) has cited about 20,000 "adverse events" from the use of Librela, along with its cat-helping sister drug, Solensia. Zoetis has reiterated that the drugs are safe and noted that the side effects amount to less than 1% of the more than 18 million shots administered.
Furthermore, not only are both drugs already Food and Drug Administration approved, but vets in Europe have given Librela a rating of 8.6 out of 10 -- the highest of any osteoarthritis drug.
While management believes Librela and Solensia could reach peak sales of $1 billion annually over the next decade, this fledgling growth area won't be a make-or-break proposition for Zoetis, which registered $8.5 billion in sales in 2023.
Steady profitability, a rising dividend, and a once-in-a-decade valuation
Zoetis' history of successful research and development (R&D) can clearly be seen in its consistently improving return on invested capital (ROIC), which recently hit 20%.
ZTS Return on Invested Capital data by YCharts
Measuring the company's profitability compared to its debt and equity, Zoetis' high and rising ROIC showcases that management is excellent at reinvesting in its operations through R&D. This 20% ROIC is double the average of the S&P 500 index, demonstrating that Zoetis continues to grow stronger with each passing year.
Armed with this robust profitability, management has lowered the company's share count by 1% annually, boosting its EPS figures over time. Additionally, it has grown its dividend by 22% each year over the last decade, raising its payments more than fivefold over that time. Despite these increases, Zoetis' dividend payments only use 30% of the net income it earned, leaving a long runway ahead for future growth.
The cherry on top for investors? Due to the short-term issues facing the company, Zoetis trades at a once-in-a-decade valuation, with a price-to-earnings (P/E) ratio of 30 and a dividend yield of 1.1%.
ZTS PE Ratio data by YCharts
Ultimately, Zoetis' discounted valuation and leadership position in the animal healthcare space make it a premium business available at a fair price -- regardless of the short-term issues facing the company today.
