Is Zoetis Inc (ZTS) Worth the Premium?

After all of the hype and hoopla over Pfizer Inc. (NYSE:PFE)‘s spinoff of Zoetis Inc (NYSE:ZTS) at the beginning of the year, Zoetis shares are basically right back where they started in 2013. There’s still plenty of interest in the animal health stock, though. Pfizer’s offer to allow its shareholders to exchange shares for Zoetis stock met with lots of takers. More than 400 million shares were swapped in an oversubscribed exchange deal.

Zoetis Inc (NYSE:ZTS)

Were these eager investors smart to swap out share of Pfizer for Zoetis Inc (NYSE:ZTS) stock? Many undoubtedly assumed that Zoetis’ growth prospects make it more attractive. But is Zoetis really worth the price?

Too expensive?
A case can be made that Zoetis Inc (NYSE:ZTS) is overpriced. The stock trades at a trailing price-to-earnings ratio of 33 and a forward multiple of almost 19. It’s not that those multiples automatically make Zoetis too expensive by themselves. After all, investors are usually more than willing to pay a premium for great growth.

However, when we look at some other health care stocks for which investors are paying more, Zoetis suffers by comparison on several fronts. For example, Biogen Idec Inc. (NASDAQ:BIIB) trades at a trailing P/E of just below 35 and a forward P/E of over 21. That’s not too far off from the levels for Zoetis.

Biogen, though, grew earnings last quarter by 41% year-over-year and increased revenue by 9.5%. Zoetis Inc (NYSE:ZTS) saw nice earnings growth, but its 26% is well below that of Biogen. The company’s adjusted net income growth of 18% was less than half of the 43% reported by Biogen. Zoetis’ revenue growth of 5% was also only around half of Biogen’s 10% top-line growth figure.

Analysts project around 15% annual earnings growth for Zoetis over the next five years and nearly 20% for Biogen. All things considered, Zoetis seems to be priced more expensively for its realized and prospective growth.

Some of the growth Zoetis that did see in the last quarter was probably only temporary. The one area that the company experienced double-digit year-over-year revenue growth was in the U.S. companion animals market. However, that growth was driven partially by a competitor’s supply issue that is now resolved.

Worth every penny?
Just looking at sheer numbers doesn’t tell the full story, though. Comparing Zoetis Inc (NYSE:ZTS) with Biogen isn’t really an apples-to-apples comparison because their markets are so different. Proponents for Zoetis would argue that the stock is deservedly priced at a premium because of its lead position in the animal health industry.

When you look at how Zoetis’ rivals are doing, the company looks pretty good. Eli Lilly & Co. (NYSE:LLY)‘s animal health unit, Elanco, increased sales by only 2% last quarter compared to the previous year. Merck & Co., Inc. (NYSE:MRK)‘s animal health business grew by 4% year-over-year — but still less than Zoetis.

While Lilly encountered headwinds outside the U.S., Zoetis experienced relatively solid operational growth in most of its non-U.S. markets. Zoetis appears to have plenty of opportunity to grow, particularly in emerging markets. For example, it only obtains less than 2% of its revenue from China — a major source of growth potential.

Both Zoetis and Merck benefited from growth in companion animal and poultry markets. Zoetis saw a decline in revenue from cattle. However, the company attributes this decrease in part to a drought experienced this year in the U.S., with cattle producers thinning their herds. Once drought conditions are over, Zoetis could see higher revenue.

The long-term prospects for animal health look good overall. As the world’s population grows, there will be an increased need for protein. This means that the demand for animal medicines and vaccines should grow. As residents of nations with emerging economies increase income levels, there will likely be a corresponding increase in pet ownership. More pets create more business opportunities for Zoetis.

Foolish take
Zoetis is a pricey stock. There certainly are stocks that offer better bang for the buck in terms of growth prospects. However, I like the quality of the growth prospects for Zoetis. The long-term secular trends that affect animal health seem solid.

Another big positive for Zoetis Inc (NYSE:ZTS) is its status as a pure play for the animal health market. With Lilly or Merck, investors must buy a pharmaceutical business to get the animal health business. That’s not the case with Zoetis after its spinoff from Pfizer. Of course, there are smaller pure plays in animal health, but Zoetis is the leader.

I think investors are paying a premium for Zoetis Inc (NYSE:ZTS) due to these factors, but the stock is a good long-term investment. If you held on to your Pfizer shares, I think you’ll be fine. If you did swap some of your Pfizer stock for Zoetis shares, I think you’ll also be fine. Both are good companies — but with different strengths.

The article Is Zoetis Worth the Premium? originally appeared on Fool.com.

Fool contributor Keith Speights has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

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