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Get Four
|  | DECEMBER 21, 2004
 FOCUS STOCK By Markos Kaminis VCA Antech: The Cat's Meow With solid earnings, a huge market, and a sharp acquisition strategy, the nationwide chain of veterinary clinics leads the pack There are several reasons why we at Standard & Poor's Equity Research Services like animal health care services provider VCA Antech (WOOF; recent price, $19.50) and view its shares as attractive for the long term. We believe it possesses characteristics common to successful small-cap growth stories. In our view, VCA offers a viable service that targets a large and attractive market in which it maintains a leadership position. We believe the company has an established and reliable track record of successful growth, which we view as sustainable. These factors should drive long-term growth and VCA's stock, in our opinion. We think recent concerns over competition, insider sales, and VCA's acquisition of Sound Technologies have provided investors an enhanced buying opportunity. Based on our discounted free cash-flow valuation, we view its shares as attractively priced. The stock carries Standard & Poor's highest investment ranking of 5 STARS, or strong buy. MORE THAN DIAGNOSTIC TESTING. We believe VCA is the leading animal health-care services company in the world. According to management, the company operates the largest network of veterinary diagnostic laboratories and freestanding, full-service animal hospitals in the U.S. Its network of diagnostic labs provides sophisticated testing and consulting services used by veterinarians in the detection, diagnosis, evaluation, monitoring, treatment, and prevention of diseases and other conditions affecting animals. With the only nationwide veterinary-laboratory network serving all 50 states, VCA provides diagnostic testing for an estimated 14,000 clients, including animal hospitals, large animal practices, universities, and government organizations. The animal hospitals offer a full range of general medical and surgical services for companion animals, as well as specialized treatments including advanced diagnostic services, internal medicine, oncology, ophthalmology, dermatology, and cardiology. It provides pharmaceutical products and performs a variety of pet-wellness programs, including routine health examinations, diagnostic testing, vaccinations, spaying, neutering, and dental care. VCA's 318 animal hospitals, supported by more than 820 veterinarians, had more than 3.5 million patient visits in 2003. We believe its target market is large and presents attractive opportunities. According to the company, the U.S. population of companion animals as of 2001 had reached about 214 million, including about 131 million dogs and cats. Industry data indicate that more than $18 billion was spent on animal health-care services in 2001, with an annual growth rate of over 10.6% from 1996 through 2001 for spending on dogs, cats, and birds. The ownership of pets is widespread, with over 58% of U.S. households owning at least one pet. As technology continues to migrate from the human health-care sector to veterinary medicine, more sophisticated treatments and diagnostic tests are becoming available to treat companion animals. We believe these new and increasingly complex procedures, diagnostic tests, and drugs are gaining wider acceptance as pet owners are exposed to these previously unconsidered treatment programs through literature and marketing programs sponsored by large pharmaceutical and pet-nutrition companies. LOTS OF LEVERAGE. Unlike the human health-care industry, providers of veterinary services are not dependent on third-party payers to collect fees. As a result, veterinary-services companies don't have the problems of extended payment-collection cycles or pricing pressures from third-party payers faced by human health-care providers. Outsourced laboratory testing is a wholesale business that collects payments directly from animal hospitals, generally on terms requiring payment within 30 days of the date the charge is invoiced. Fees for animal-hospital services are due at the time of service. Over 95% of VCA's animal-hospital services are paid for in cash or by credit card at the time of service. This has resulted in reliable cash flows. Over the past three years, VCA's bad-debt expense has averaged just 1% of total revenue. Operating as a leader in a large, yet fragmented, market allows VCA the opportunity to leverage economies of scale as it consolidates small operators. It can better leverage advertising, vs. smaller rivals, and build brand value and customer awareness, in our opinion. The company can also leverage its size when making supply-and-equipment purchases. It can also leverage brand value and technological strengths to differentiate itself to achieve better pricing, if it so desires, or leverage cost advantages to be the low-cost industry provider, in our view. BROADENING SCOPE. We believe competition finds profitable opportunity, and the increasing presence of VCA rival Banfield, The Pet Hospital is a sign of this situation. However, with a market as large as veterinary care, and one that is significantly fragmented, we believe there is room for two larger players. During our visit to VCA this year, we gained some insight into management's strategic mindset. We believe the current growth strategy of acquiring veterinary hospitals will continue into the foreseeable future, and we think that makes sense with a large market opportunity still available. We also believe the operation is seeking to broaden the scope of diagnostic testing by providing a higher level of diagnostic tools and tests. The acquisition of Sound Technologies in October, 2004, exemplifies that effort. Although the deal represents entry into manufacturing, we believe the addition of the technology will strengthen the capabilities of VCA's diagnostic and veterinary hospital businesses by allowing its veterinarians to take an X-ray or ultrasound onsite, and have a specialized technician examine it and provide a diagnosis. In the case of digital radiology, that diagnosis could be performed quickly from another location.
BW MALL
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