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WOOF: Health Care Without the Drama

- By Robert Abbott

Considering demographics, innovative new treatments and other issues, health care for people ought to be a great industry in which to invest. However, political and regulatory risk make it one of the most uncertain.

But do not close that door yet. Another area of health care exists, one in which the demographics and other trends are favorable, and without the political and regulatory uncertainties: pet health care. Or as they call it in the business, companion animal care.


Owners are lavishing ever increasing amounts of attention and money on their pets (Disclosure: I am one of them, too!). At the same time, veterinarians and others in the pet care industry are introducing more levels of care. Not long ago, dogs and cats basically lived or died; if they got sick they were simply put down. Today, though, veterinary care includes everything from dental to cancer treatment.

There should be an opportunity for investors here. A number of companies are trying to make the most of that opportunity, including VCA Inc. (WOOF), the one with the engaging stock symbol.

Here's an investor's perspective on VCA, through a 10-year chart:

VCA 10 year price chart

History

1986: Veterinary Centers of America founded by three former executives at AlternaCare.

1987: Acquires its first veterinary hospital.

1994: Sets up a partnership with H.J. Heinz Co.

2001: VCA Antech begins trading as a publicly-owned company.

2012: Expands into Canada through an increased investment in Associate Veterinary Clinics (1984) Limited.

2014: Acquired Camp Bow Wow Franchising Inc., which expands its business in the dog boarding and daycare service segment.

2015: Divested Vetstreet Inc.

2016: Over 800 animal hospitals in the U.S. and Canada.

History based on information from the company's website and 10-K for 2015.

Although the company provides few details of its history, it has clearly grown quickly in the 30 years since its founding. Acquisitions have played a role.

VCA's business

VCA Inc. is in the pet business, with several different lines but with most of the emphasis on pet health care (unless otherwise noted, information here comes from the company's 10-K for 2015). Those lines are:

  • Animal hospitals: A full range veterinary services, including advanced diagnostics and pet wellness programs. It had some 9.8 million patient visits in 2015.
  • Veterinary diagnostic laboratories: Testing and consulting services used by veterinarians; provides diagnostic testing for over 17,000 clients, including standard animal hospitals, large animal practices, universities and other government organizations.
  • Medical Technology: Sells digital radiography, ultrasound imaging and other advanced imaging and diagnostic equipment, education and training on the use of equipment, and consulting and mobile imaging services.
  • Pet services business: Franchises a provider of pet services, including dog day care, overnight boarding, grooming and other ancillary services, under the trademark Camp Bow Wow.



For reporting purposes, VCA reports in two segments: Animal Hospital and Laboratory. The Medical Technology and Camp Bow Wow operations do not meet materiality requirements and are grouped into an "All Other" category.

  • Animal hospitals: At the end of fiscal 2015, VCA operated or managed 682 animal hospitals in 41 states and four Canadian provinces. This segment accounted for 79% of total consolidated revenue in 2015, 2014 and 2013.
  • Laboratory: A network serving all 50 states and certain areas in Canada. Laboratory revenue accounted for 16% of total consolidated revenue in 2015, 2014 and 2013.



The company reported in its third quarter financial results that it had acquired 49 independent animal hospitals in the latest three months, with combined annual revenue of $146 million.

VCA Inc. is built around the animal hospital business, which accounts for almost four-fifths of its annual revenue, with complementary businesses providing the remainder.

Revenue

The following chart shows VCA's revenue growth over the past 10 years:

VCA revenue

Turning to a related metric, GuruFocus reports the following average annual revenue per share growth rates:

  • 12 months: 18.6%
  • Three years: 10.5%
  • Five years: 9.7%
  • 10 years: 8.6%.



The company has demonstrated its ability to grow revenue, with the pace of revenue per share picking up in recent years.

Competition

VCA reported in its 10-K that the pet health care industry is highly competitive and faces continual changes.

For animal hospitals, it believes the main competitive issues are location and hours, personal recommendations, reasonable fees and quality of care. Primary competitors are individual and small multi-clinic practices, while at the same time, Banfield Pet Hospitals and National Veterinary Associates operate competing networks. In addition, some internet vendors sell pet -related products and diagnostic services.

Here are the current holdings of the big three:

  • Banfield: more than 900 hospitals
  • National Veterinary Associates: 417 hospitals
  • VCA Inc.: more than 800 hospitals



For veterinary diagnostic laboratories, it says quality, price, specialist support and the time required to deliver results are the major competitive factors. Its principal competitor in the United States is IDEXX Laboratories Inc. (IDXX). For the Medical Technology business, competitors include such giants as Siemens (SIA.AS), Philips (PHIA.F) and Canon (CAJ).

Hoover's lists its three main competitors as: Idexx Laboratories Inc., PetSmart (a subsidiary of BC Partners, a private equity firm) and Medical Management International Inc. (which owns Banfield Pet Hospitals and is a subsidiary of privately held Mars Inc.).

It is undoubtedly a competitive business, but with VCA adding more than a hundred hospitals in the past year, it appears able to hold its own.

Moat

As seen in previous sections, VCA has grown its footprint and its revenue; indeed, its revenue growth has accelerated in the past couple of years.

Over the past five years, it has more than doubled its free cash flow to more than $222 million in fiscal 2015.

It operates in four areas, most recently adding pet services such as dog day care and overnight boarding. Having these complementary services allows cross-selling and other opportunities.

The company sums up its competitive advantages in this 2016 Investor Presentation:

VCA moat

While VCA has strong competitors in each of its operating sectors, it has enough positives to give it at least a narrow moat.

Growth

As noted above, VCA's revenue has grown. But it has grown on other metrics as well.

The company says the key elements to its business strategy are:

  • Capitalizing on its leading market position to generate revenue growth;
  • Leveraging its established infrastructure to improve margins;
  • Using its enterprise-wide information systems to improve operating efficiencies; and
  • Pursuing selected acquisitions.



The fourth of these strategic elements is likely to provide the greatest growth as the industry consolidates and owners take increasing care of their pet's needs.

Other

VCA Inc. is incorporated in Delaware and headquartered in Los Angeles, California.

At the end of 2015, it had the equivalent of 12,700 full-time employees.

Chairman of the Board, President and Chief Executive Officer Robert Antin has led the company since its founding in 1986.

Chief Financial Officer, Vice President, Principal Accounting Officer and Secretary Tomas Fuller has held the top financial post since 2011 (officer information from Reuters.com).

Ownership

Seven of the guru investors followed by GuruFocus own shares in VCA Inc. Jim Simons has the largest position at 615,000 shares; that gives him an ownership of just over three-quarters of one percent. Columbia Wanger (Trades, Portfolio) and Pioneer Investments (Trades, Portfolio) have the second and third largest stakes, respectively.

In general, institutional investors (mutual funds, pension funds and others) have a large stake in VCA:

VCA ownership

Interestingly, the current institutional stake is down from 99% level in 2012 and 2013.

Short sellers, who expect the price of the company's shares to fall, have a small stake.

Chairman and CEO Antin continues to hold a significant number of shares at 153,725 shares, meaning he retains a 0.19% ownership of the company.

The respective holdings of institutional investors, shorts and insiders suggest this company is relatively stable and safe to hold.

VCA by the numbers

VCA key statistics

A mid-cap stock with a price some distance from the 52-week high and low; return on equity is strong; it pays no dividend; and it bought back 2.6% of its own shares in 2015.

Financial strength

The GuruFocus system gives VCA a 6 out of 10 for financial strength and an 8 out of 10 for profitability and growth:

VCA financial strength

Note the red icons on the Cash to Debt line, which signals where much of the weakness in the financial score originates. The company's long-term debt compares unfavorably with that of its peers, and with its own history. Here is a 10-year chart (ending with fiscal 2015) showing the growth of debt at VCA:

VCA long-term debt

As the chart tag indicates, debt has grown 86% over those 10 years. In its 10-K for 2015, the company says, ". . . we had a leverage ratio of 2.07 to 1.00, which was in compliance with the required ratio of no more than 4.25 to 1.00 from June 30, 2015 through Dec. 31, 2015 as defined under the senior credit facility. The senior credit facility defines the leverage ratio as that ratio which is calculated as total debt divided by pro forma earnings."

GuruFocus posts one medium warning sign for VCA, noting that the company's debt has increased, "But overall, its debt level is acceptable."

Over that last decade, revenue has more than doubled:

VCA revenue

The same holds for Ebitda (Earnings before interest, taxes, depreciation and amortization):

VCA EBITDA

Free cash flow also has grown along with the long-term debt:

VCA free cash flow

One other note from the 10-K, "We intend primarily to use cash in our acquisitions but, depending on the timing and amount of our acquisitions, we may use stock or debt."

While long-term debt pulls down VCA's financial strength rating, it has used that debt to materially increase its revenue, Ebitda and free cash flow.

Valuation

VCA receives a 4 out of 5-Star rating for predictability, which means it has consistently grown its earnings (Ebitda). That (along with its price) was enough to recently earn it a place on the Undervalued Predictable screener list, and to indicate that it is likely to produce capital gains for its owners if held for the long term.

On the valuation side, GuruFocus says, "VCA Inc is more suitable for Earning Power Based valuation methods. This includes 1) Median P/S Value 2) Peter Lynch Fair Value. The Median P/S Value of VCA Inc for today is 51.77. The Peter Lynch Fair Value of VCA Inc for today is 64.33." The Discounted Cash Flow calculator comes in with a price of $30.39, 113% below the Dec. 9 close of $64.64.

Price-earnings is a relatively high 22.8, but that is roughly in the middle of the range it has traversed over the past 10 years:

VCA P/E

The PEG (price-earnings divided by earnings growth) comes in at 1.53, which puts it in the middle of the fair value range.

The analysts followed by NASDAQ.com have a 12-month consensus target of $75.50, which is 16.8% above the Dec. 9 closing price. They are also quite bullish on the stock:

VCA analysts research

VCA has posted strong and consistent earnings growth, making it a stock of substance. And while the stock has pulled back from its 52-week high, it is more likely fairly valued than undervalued based on the P/E and the opinion of analysts.

Conclusion

Cautious value investors will want to pass on VCA Inc. because of its long-term debt levels. This company has used, and undoubtedly will continue to use, debt to grow.

Similarly, income investors will see no place for this stock in their portfolios because it does not pay a dividend, nor is there any indication it will.

Instead, this is a stock for growth-oriented investors willing to trade off the company's debt and its mid-cap status for a shot at seeing the share price grow by mid-teen percentages next year and likely for several years after that.

Disclosure: I do not own stock in any of the companies listed in this article, nor do I expect to buy any in the next 72 hours.

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This article first appeared on GuruFocus.