Ricky Sandler’s Eminence Capital reported a position of 4.8 million shares in VCA Antech Inc (NASDAQ:WOOF), which operates animal hospitals and veterinary research laboratories, in a recent 13G filed with the SEC. This gives the fund 5.4% of the total shares outstanding. Since we track quarterly 13F filings from hedge funds as part of our work developing investment strategies (for example, the most popular small cap stocks among hedge funds generate an average excess return of 18 percentage points per year), we can see that this position is a substantial increase from the 3.4 million shares the fund had owned at the beginning of April. Before that point, Eminence had more than tripled its stake during the first quarter of 2013. See Sandler’s stock picks over time.
Last quarter, VCA Antech Inc (NASDAQ:WOOF) grew its revenue by 7% compared to the first quarter of 2012. Margins did come down a bit, with the result being that pretax income increased only 2% after we subtract out a business combination adjustment gain from last year’s Q1. Revenue growth was concentrated in the animal hospital segment, which is a considerably lower margin business than laboratories: animal hospitals provide 78% of VCA Antech’s revenue but roughly the same amount of operating income as the smaller segment. The company seems to be an excellent cash flow generator, with investing activities consuming only about a third of cash flow from operations.
At its current market capitalization of $2.3 billion, VCA Antech Inc (NASDAQ:WOOF) trades at 19 times adjusted trailing earnings. Given that the animal health business hasn’t seemed to grow that much, the stock doesn’t look like too much of a good value to us- even if margins hold steady, and earnings begin to grow at the same rate as revenue, the current pricing still wouldn’t be that attractive. Analyst expectations imply a forward P/E of 16. P2 Capital Partners, managed by Claus Moller, has had VCA Antech as one of its largest holdings by market value (fnd Moller’s favorite stocks). Jeffrey Smith’s Starboard Value initiated a position of 750,000 shares between January and March (check out more stocks Starboard was buying).
The closest peers for VCA Antech are IDEXX Laboratories, Inc. (NASDAQ:IDXX) and Petsmart (NASDAQ:PETM). Petsmart’s recent financial performance is similar to VCA Antech’s, with revenue and earnings up moderately in its most recent quarter compared to the same period in the previous fiscal year. The trailing P/E is 19, about even with where VCA Antech trades despite the two companies addressing different needs of pet owners. IDEXX is valued at a premium to these peers, with both its trailing and forward earnings multiples being over 20. Its net income rose 10% in the first quarter of 2013 versus a year earlier, but revenue growth was much lower and so we’d be skeptical that this degree of improvement in earnings is sustainable.
We can also compare VCA Antech Inc (NASDAQ:WOOF) to companies which operate human hospitals, such as HCA Holdings Inc (NYSE:HCA) and Tenet Healthcare (NYSE:THC). These two stocks carry forward P/Es in the 11-13 range; we’d imagine that part of the reason for this discount is that investors are concerned about future government policy regulating the (human) healthcare sector. Revenue growth at these two companies has been limited as well; however, their stock prices have exhibited strong performance with HCA up over 50% in the last year and Tenet more than doubling in price.
We’re not sure what Sandler and his team see in VCA Antech Inc (NASDAQ:WOOF). The company is growing its business but margins are falling as at least for now its highest-growth area is in relatively low margin animal hospitals. The current valuation already includes substantial future earnings growth, and with recent financials not being particularly strong we would avoid the stock at least for the time being.
Disclosure: I own no shares of any stocks mentioned in this article.
