Meaty Bones: Animal Health Stocks

07/23/2015 7:00 am EST

Focus: STOCKS

Linda McDonough

Hedge Fund Analyst, Profit Catalyst Alert and Growth Stock Strategist

Animal spirits are alive and well in the veterinary sector; we have seen rapid consolidation in the animal health sector over the last year, explains Linda McDonough, in Investing Daily's Small Cap All Stars.

Companies in the drug and diagnostic area are keen to diversify their medical operations into the sale of veterinary products, which are paid for out of pocket and are less susceptible to generic competition.

In addition, drugs and diagnostic products for animals are not subject to lengthy FDA reviews, allowing companies to turn around animal research dollars much faster than those allocated to human drug development.

The recent acquisition spree began in April 2014 when Eli Lilly (LLY) agreed to acquire Novartis Animal Health. Since then, AmerisourceBergen (ABC) agreed to buy MWI Veterinary Supply and Patterson Companies (PDCO) bought Animal Health International.

Although there are fewer independent names left in this industry, we've uncovered a few meaty bones that offer exposure to this highly profitable sector.

In my view, IDEXX Laboratories (IDXX), the kingpin in diagnostic veterinary tests, and VCA Inc. (WOOF), both offer investors a tasty treat.

Although IDEXX Labs trades at 18 times EBITDA, its business of selling diagnostic blood tests to vets is more than 5 times as profitable as MWI Veterinary Supply and Animal Health.

This level of profitability comes as no surprise to this pet owner who gasped at the $400 charge for routine IDXX blood tests done on her Basset Hound during an annual visit to the vet.

A recent weak quarter—due to the transitioning of some distribution channels—put IDEXX in the doghouse. Its stock is down 15% year-to-date but this bump in the numbers is likely temporary.

IDEXX's high level of profitability and above average 8% revenue growth make this a thoroughbred investment.

Meanwhile, VCA continues to demonstrate purebred growth. In the most recent quarter, revenue grew 11%, an acceleration from the company's 2014 annual growth rate.

As a service provider, VCA is slightly less profitable than IDEXX but its valuation of 13 times EBITDA reflects those numbers.

As the medical industry continues to froth at the mouth for above-average growth and profitability, these two stocks will leave investors purring. Even without getting adopted by larger conglomerates, IDEXX and VCA are excellent companions for any portfolio.

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More from MoneyShow.com:

Healthcare REITs: A Healthy Duo

Novartis and Glaxo: Deal Making Duo

S&P Eyes Healthcare M&A

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