CAPScall of the Week: Zoetis

For years, satirical late-night TV host Stephen Colbert has been running a series on his show called "Better Know a District," which highlights one of the 435 U.S. congressional districts and its representative. While I am no Stephen Colbert, I am brutally inquisitive when it comes to the 5,000-plus listed companies on the U.S. stock exchanges.

That's why I've made it a weekly tradition to examine one seldom-followed company within the Motley Fool CAPS database, and make a CAPScall of outperform or underperform on that company.

For this week's round of "Better Know a Stock," I'm taking a closer look at Zoetis (NYSE: ZTS  ) .

What Zoetis does
Zoetis is the animal health division that Pfizer (NYSE: PFE  ) spun off a 17% stake in as of Friday. Zoetis manufactures various pet medications and vaccines throughout the world and directly supplies them to livestock owners and veterinary offices.

According to Zoetis' SEC filings, the company reported revenue of $3.2 billion through the first nine months of the year, a 1.7% increase over the year-ago period, while net income soared 87% to $446 million. Zoetis' S-1 filing in August points out that 66% of its 2011 revenue was derived from livestock (primarily cattle and swine), while the remaining 34% came from companion animals. Geographically, 39% of Zoetis' sales came from the U.S. in 2011, with Europe, Africa, and the Middle East adding another 27%.

Whom it competes against
There are quite a number of competitors in the animal medications and vaccines sector, including Merck (NYSE: MRK  ) Animal Health, Sanofi's (NYSE: SNY  ) Merial, and Eli Lilly's (NYSE: LLY  ) Elanco.

Zoetis boasts the biggest piece of what's currently estimated by Pfizer to be a $22 billion animal health market, with $4.2 billion in revenue in 2012. This compares to $3.4 billion in sales from Merck Animal Health based on its 2012 annual results reported Friday, $2.8 billion for Sanofi's Merial as of its 2011 annual report, and $2 billion for Eli Lilly's Elanco in 2012.

What's really worth noting that is that these four pharmaceutical companies all reported higher year-over-year pet product sales. This reemphasizes my initial point from two weeks ago that the pet products market is expanding and everyone's piece of the pie can grow, even if market share statistics tend to be a little fluid. A growing population will increase the demand for healthy and growing livestock, and the ever-growing adoption of companion pets as genuine members of the American family is a trend that should push revenue at all of these animal health companies and divisions higher.

On the flip side, let's keep in mind that Pfizer still maintains an 83% stake in Zoetis, so it isn't off the leash just yet. Pfizer hasn't made any poor decisions with regard to Zoetis; I'm merely pointing out that management's flexibility is limited with Pfizer still firmly in control.

The call
After carefully pondering the merits of Zoetis, I've decided to initiate it with a CAPScall of outperform.

Ultimately, I really wish Zoetis didn't pop 20% in its debut, but I nonetheless see an incredible value in just about all animal-oriented companies over the long term. As I've opined, pet owners tend to spend whatever is necessary to ensure the health and long life of their pets. This plays perfectly into the hands of Zoetis, the world's largest animal health pharmaceutical and vaccine maker.

Furthermore, we've really only hit the tip of the iceberg with regard to animal research. Pfizer's research pegs the current market value at $22 billion. IMS Health pegged the value of the global pharmaceutical market for humans around $880 billion in 2011! There's a boom in animal research yet to come. In the meantime, relatively few medications between these four big providers offer much competitive overlap. This means that patent expirations are often moot points, and advertising can be kept to a minimum since few treatment options for specified ailments exist, boosting animal health companies' margins.

Finally, and possibly most importantly, pet owners aren't likely to carry health insurance for their pet. This means that medication costs come out of pocket and result in higher margins for Zoetis.

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