IDEXX Barking Up the Right Tree
Related Stocks: IDXX, WOOF
Diversified Animal Care Business
Idexx has three business segments dedicated to diagnostic tools for several purposes. Here is a description of each business:
Companion Animal Group: This is the largest and most important business segment for Idexx with the majority of revenue and an approximate 15% growth rate. The CAG caters to pet health diagnostic tools and veterinary medicine. The products offered by this segment include animal pharmaceuticals, instruments for veterinarians, and off-site laboratory processing.
Idexx dominates the market for veterinary diagnostics. Many health care conglomerates like Abbot, Siemens, and Roche sell blood sample analyzers, but Idexx has found a niche market by specializing for the animal care industry.
The closest direct competitor is VCA Antech (WOOF), which also provides off-site laboratory and consulting services. However, I believe Idexx has a differentiated market position because the core of its business is point-of-service hardware sales. New product releases in 2008 will allow more tests to be performed at the vet’s office, rather than at far-away labs.
Production Animal Services: The PAS division provides diagnostic tools for measuring the health of livestock and testing production quality. One of the major product lines test for antibiotic reside within dairy products.
Despite currently contributing less than 10% of sales, the PAS is the fastest growing segment with above 20% growth. Management has high hopes that their 95% owned joint venture in China will become a huge growth segment. On the Q2 2006 conference call CEO John Ayers stated that a lot of opportunity is ahead in China with its “6 billion chickens and 40 million pigs.”
Water Testing Products: In addition to its animal care products, Idexx also sells kits and instruments for testing bacterial contamination in water. In 2006, 42% of the sales in this segment were international. Although this business sounds exciting, it only has a 2-3% growth rate and comprises a small, but stable portion of the business.
Overall the company has delivered a surprisingly stable 15%-16% revenue growth rate over the past several years. Having a global footprint seems to have helped this company. On the Q2 2006 conference call, John Ayers stated. “It’s [strong sales] all over. North America. It’s in Europe. It’s in the developed economies of Asia.”
New Product Releases
Idexx is driven by sales of instruments and their associated consumable parts. The consumable parts are disposable and actually carry higher profit margins than the instruments themselves. This is a clever marketing technique for Idexx because it is similar to the sale of razor blades or ink cartridges for your printer.
I expect 2008 to be a terrific year for Idexx because the release of new products should provide a strong catalyst. Three product releases are currently planned, of which the two most important are Catalyst DX and SNAPShot.
These two products will revolutionize the way veterinarians perform tests. They will offer more extensive reporting and allow a greater variety of sample tests to be run at the veterinary clinic rather than being sent to an off-site lab. Keep in mind that the sales of disposable parts for these instruments area also important.
According to William Blair research, preliminary market tests show a very favorable demand for these new products. William Blair research also believes that management may opt to limit early sales of these units to help find glitches earlier in the life cycle. This may set up a perfect “under promise, over deliver” situation for later 2008 quarters.
Financials
Idexx has a terrific balance sheet. It has a strong Free Cash Flow and very little long-term debt. The company has been rampantly repurchasing stock. Over the past year, they have taken back about 2.2% of their total shares.
From a portfolio management perspective, the characteristics of the stock provide good diversification. I performed a 3-year regression of the daily price movements against the S&P 500 and calculated a beta of 0.54. This would indicate that IDXX is less sensitive to the overall market’s systematic risk. In a high volatility time, this might make it a good holding for a growth stock portfolio.
Valuation at Risk
My one reservation at the moment is the stock’s valuation. It’s forward PE multiple is now close to 30, at the high end of its fluctuations. In the past this stock has been susceptible to multiple contraction.
At the end of October 2006, despite reporting good numbers and raising revenue guidance, the stock slipped 12% and the forward PE multiple deflated. I this might have been triggered by a revised 2007 EPS estimate of $3.00 – 3.12 vs. the Street’s consensus of $3.14 at that time.
Because the PE multiple is relatively high at the moment, I would recommend building a position defensively. Any weakness I would consider a buying opportunity.
Barking up the Right Tree
According to BusinessWeek Americans spend an estimated $41 billion per year on their pets, with that figure expected to grow at a CAGR of 12.25% for the next two years. The pet industry is a terrific growth story and when it comes to animal diagnostics, its easy to say that Idexx is the best of breed
Full Disclosure: At the time of this writing, Winston holds a small long position in IDXX.
