硕腾

Zoetis reported second-quarter results with flat top-line growth and earnings down 5% year over year, driven by an 11% decline in US companion animal revenue. Zoetis significantly reduced revenue guidance by 550 basis points at the midpoint and earnings per share by $0.82 at the midpoint.

Why it matters: Zoetis has been caught on its back foot as Elanco (and soon Merck) has been fighting for share in the canine dermatology market. Signs of softening in Zoetis' US companion animal business seen in the first quarter have intensified. Though management has pointed to declines in vet visits as one reason for the drag on companion animal growth, we think the more material factor has been Elanco's push into Zoetis's key markets—dermatology and triple-combo parasiticides. Zoetis's position in the dermatology market is likely to slide even further as Merck moves into the full launch of Numelvi (which competes with Apoquel) and Elanco rolls out Befrena (which competes with Cytopoint).

The bottom line: We've lowered our fair value estimate to $102 per share, down from $140, after assuming the companion animal segment declines 8.5% in 2026, and another 4% in 2027, before returning to positive low-single-digit growth in 2027. We also dialed down our profitability projections, following management's acknowledgment that Zoetis is taking price actions to fend off competition and defend market share. We now assume gross margin falls by nearly 500 basis points, bottoming out in 2027 at 67%. Despite anticipated share loss, slower growth, and eroding margins over the next two years, Zoetis' return on invested capital remains in the mid-20s, well above average cost of capital, and we're leaving its wide moat intact. Shares remain undervalued, in our view.

Big picture: For a firm that has rarely made a misstep, it's become clear this quarter that Zoetis doesn't seem to have appropriately prepared for the kind of competition Elanco and Merck are ready to engage in.

In this vein, we view the abrupt announcement of CFO Wetteny Joseph's imminent departure and incoming CFO Jay Saccaro's start date in less than two weeks as management acknowledgment that there were shortcomings in recognizing what has turned into a major share fight.

For most of its independent life, Zoetis has outperformed the field by launching novel therapeutics, establishing a beachhead, and then enjoying a monopoly-like position. As we've discussed in the past, this is the first time Zoetis has had to pivot to playing defense—an unfamiliar position.

Management also indicated that consumers feeling financial stress has been another factor in softening demand for certain products. We think there is some credence to this perspective. For example, CEO Kristin Peck called out Cytopoint (a monoclonal antibody for atopic dermatitis) as one where Zoetis is seeing some price sensitivity among pet owners. Our research suggests the monthly cost for a Cytopoint injection for a 12-pound dog averages $70, while the price for the largest breeds runs up to $240. We think it is plausible that pet owners are tightening their belts by, perhaps, stretching out doses to every six weeks or longer.

Nonetheless, we think Elanco's aggressive competition has played the most significant role in hampering Zoetis's recent results. There are indications that Elanco has been pricing its Credelio Quattro and Zenrelia products extremely aggressively to convert customers. We expect more of the same as it launches Befrena.

Thus, our question has been, at what point would Elanco no longer be able to maintain this kind of low price? And how would that stack up against Zoetis's tolerance for share loss? Up until the second quarter, Zoetis management had been adamant that it would not compete on price. This quarter's conference call was the first time we saw management soften its stance and acknowledge that it would need to increase promotional activity to play defense.

Considering Elanco's margins, it's unlikely it will be able to quash prices in the long term. At this point, we assume Elanco can press on price through 2027 on its key new companion animal products. Accordingly, we assume that Zoetis will see consecutive declines in its companion animal segment, along with significant margin pressure until it can launch more of its novel therapies in the pipeline, including one for canine renal disease and another for canine oncology.

We've cut our fair value estimate to $102 per share from $140, after incorporating declining projections for companion animal revenue in 2026 and 2027, before assuming gradual recovery in segment growth from innovative products starting in 2028. We now estimate 2026 companion animal revenue will fall 8.5%, which puts us below management's outlook. Negatively, we assume that Zoetis permanently cedes significant market share in dermatology and triple-combination parasiticides through 2030. In the midterm, though, we anticipate the firm will introduce novel canine therapies for kidney failure and cancer—two undertreated markets that Zoetis would pioneer —thereby supporting a return to mid-single-digit growth in the companion animal business by 2030. This translates into consolidated average annual revenue growth of 1% through 2030—down 300 basis points from our previous projection.

We also dialed down our profitability projections, following management's acknowledgment that Zoetis is taking price actions to fend off competition and defend market share. We now assume gross margin falls by nearly 500 basis points, bottoming out in 2027 at 67%.

The production animal segment has anniversaried the sale of the medicated feed portfolio, but we expect normalized low-single-digit growth over the longer term as generic and competitive pressure increase. The main factors that could accelerate production animal growth would be periodic disease outbreaks, though these usually offer one-time benefits before the outbreak dissipates.

Zoetis enjoys a wide economic moat thanks to its significant intangible assets. Similar to human pharma companies, Zoetis benefits from patents that allow it to charge a premium price and insulate it from competition. Currently, Zoetis owns over 5,880 patents, with another 1,500 pending. This is roughly 900 more than at freestanding rival Elanco. Further, as with other pharma firms, Zoetis relies heavily on composition of matter patents, which offer particularly strong protection.

Most recently, Zoetis has reached commercial success with several monoclonal antibodies for companion animal use. As with other biologic therapies, replicating Cytopoint, Lenivia and Solensia will likely be challenging for competitors after patents expire. We anticipate Zoetis will maintain its leadership position in monoclonal antibodies and extend its presence on this platform into additional therapeutic areas (for example, cardiac, renal, and oncology).

Zoetis enjoys another intangible asset in the form of strong brand names on specific products. We think this is a particularly significant dynamic in companion animal products, where consumer familiarity and veterinarian recommendation play a role. When customers are using drugs on a pet that is, for all intents and purposes, another family member, they are willing to pay a premium to buy the brand that their vet trusts and that they think has worked well for their pet. We’ve seen this pet owner preference manifest in a very long tail after the patent on Rimadyl (nonsteroidal anti-inflammatory for arthritis) expired 30 years ago.

Zoetis also enjoys another intangible asset, in comparison with its competitors that are embedded in larger human pharmaceutical firms: It is free to develop therapeutics based on unmet animal needs. For most competitors, application of therapeutics originally designed for humans to the animal market also means those firms are unlikely to invest in animal-specific therapies. There are some sizable opportunities related to unmet animal needs that Zoetis can pioneer, including Cytopoint for canine allergies.

In terms of environmental, social, and governance issues, Morningstar Sustainalytics rates Zoetis as low risk. Considering the probability and materiality of the key risks, we do not see much risk of an ESG matter permanently impairing Zoetis' moat. From our perspective, most of the risk lies with product governance. There is the risk of potentially defective products harming pets, though we doubt this leaves the firm vulnerable to much in the way of legal liability, given the lifespan and market value of dogs and cats.

There is also the possibility that medications ingested by production animals make their way into the human food supply. This issue has taken on a higher profile recently thanks to more evidence of rising antibiotic resistance and concerns about milk containing growth hormone given to dairy cows to increase production. We've seen much of the immediate risk dissipate through a combination of greater regulatory scrutiny, industrywide decisions to respond to consumer concerns, and management’s decision to divest some of its medicated feed products. This has translated into a reduction in Zoetis' exposure to this risk.

Finally, we think there is a longer-term risk in the form of more consumers embracing vegetarian/vegan diets or reducing the volume of meat consumed in the interest of mitigating the environmental impact of raising production animals. This is especially true in the industrial farm model. There is also the potential commercialization of lab-grown meat, which could reduce demand for production animal therapeutics. Nonetheless, we view these risks as long-term issues that are unlikely to disrupt Zoetis' business unexpectedly, and we anticipate an ongoing mix shift toward the companion animal division, which should also offer some insulation from production animal challenges.

Growing interest in probiotics, antibacterial peptides, and immune modulators as alternatives to antibiotics offers many targets for innovation.

Companion animals are increasingly viewed as family members, drastically increasing owners' willingness to spend on pet healthcare.

Because the animal health industry lacks large payers like Medicare, single-payer governments, or large insurance companies, Zoetis maintains significant pricing power.

Strict regulation or restriction of antibiotic use in animals could harm Zoetis' sales of production animal products.

New safety data might not assuage pet owner concerns about Librela in the US, which might lead to further declines through 2026.

Recessionary conditions and financial stress could pressure pet health spending and pet adoption or even increase pet surrenders.