AGB 2024.6 - IDEXX Laboratories (IDXX)
Diagnostics for Companion Animals
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IDEXX Laboratories
“Our strategy as a company is to be able to drive the relevant use of diagnostics through all life stages of a pet's life, because we think it's just so effective at uncovering disease and providing the veterinarian with the tools to identify what the best possible treatment is. And so, we've seen a steady increase in diagnostics both from an adoption and utilization standpoint.” - CEO Jay Mazelsky at IDEXX’s 2023 Investor Day
IDEXX is the leading provider of diagnostics instruments, tests and services for the companion animal veterinary industry. The company serves veterinary practices by providing the necessary tools to diagnose illnesses and diseases. Diagnostics are becoming an increasingly larger contributor to the financials of their customers. As IDEXX’s diagnostic instruments and services become an essential part of veterinary practices, these customers tend to also adopt the company’s software offerings like practice management (ezyVet, Neo), order management (VetConnect Plus) and customer engagement (Vello).
IDEXX has three segments, the Companion Animal Group (CAG), Water and Livestock, Poultry and Dairy (LPD). Over 91% of 2023 revenues were from the CAG segment, so the other two segments don’t get as much attention because of their minimal impact to the financial model. We’ll go over them quickly.
Water was 4.6% of 2023 revenues and has the highest margins of the three segments at 69% gross margins and 44% operating margins. This segment is comprised of water testing instruments, mainly to detect the presence of coliform bacteria and E. coli in water. These tests are mainly used by government labs and utilities to test drinking water to comply with regulatory standards for over 2.5B people. The water testing segment commands the company’s highest level of customer retention at 99+%.
LPD was 3.3% of 2023 revenues and has the lowest margins at 54% gross margins and 8% operating margins. This segment provides instruments, tests and services for livestock, poultry and milk safety. The three main tests are for Bovine Viral Diarrhea Virus, Porcine Reproductive and Respiratory Syndrome and African Swine Fever. China is a large part of the international portion of this segment, which has been a headwind recently.
CAG was 91.6% of 2023 revenues and has seen improving operating margins over the past 10 years as this segment has benefited from increasing scale and higher contributions from consumables. CAG is broken down into smaller categories but the main ones are instruments, consumables, rapid assay products (SNAP), reference lab services and software.
Within diagnostics, IDEXX started out by mainly selling SNAP rapid assay tests (10% of 2023 CAG revenues). These are single-use test-kits for certain diseases including Lyme disease, heartworm infection, feline immunodeficiency and leukemia and others. Most SNAP tests can be run without the use of instruments, but they can also be further analyzed using an instrument like the company’s SNAP Dx/Pro Analyzers. Rapid assay test revenues have increased over time but are shrinking as a % of the CAG segment due to outpaced growth in consumables used for in-clinic instruments.
The company then evolved to offer reference lab services (38% of CAG revenues). This is where samples are sent from a veterinary practice or hospital to one of IDEXX’s 80+ labs around the world, usually through same-day or an overnight delivery service. Certain lab tests can also be run in-clinic with the use of instruments but many are specialized tests that can only be run in the lab. The company’s reference labs handle the most complex cases involving immunology, renal, oncology and parasitology related diseases and illnesses. IDEXX’s reference labs service 65k customers/year. Reference lab revenues have grown in-line with the rest of the CAG segment over the past 10 years.
The company’s main growth areas in the CAG segment are instruments (4% of CAG revenues) and the related consumables (35% of CAG revenues). IDEXX sells instruments to veterinary practices and hospitals so that they can provide their clients with detailed diagnostic information about their pets in-clinic, which have much quicker turn-around times than reference lab tests. These are the main classes of instruments that IDEXX sells currently:
Catalyst Dx/One – Chemistry analyzers providing comprehensive diagnostic testing
ProCyte Dx/One – Hematology analyzers providing detailed blood cell analysis
SediVue Dx – Urine sediment analyzers providing advanced bacteria detection
Catalyst analyzers make up about half of the installed base, ProCyte 35% and SediVue 13%. On average, an instrument generates roughly $8.5k-$9k of consumables revenues each year (though it’s implied that Catalyst instruments generate much higher consumable volumes than the average). Consumables have outpaced the growth of the other areas within the CAG segment over the past 10 years. This trend should continue as IDEXX increases the installed base of instruments through its existing line of products and future lines like the inVue Dx Cellular analyzer coming out in late 2024.
The company typically expands the menu of tests that can be run on existing instruments over time so that veterinary practices can continue to get value and effectiveness from their existing instruments. For example, the Catalyst DX instrument which was launched in 2008 has added the ability to test for a dozen or so additional diseases since then. In 2023, consumables revenue from these new tests for the Catalyst instruments accounted for $280M, which is 25% of total consumables revenues.
Because most of the CAG segment revenues are recurring (88% in 2023), organic revenue growth is influenced by certain growth factors. It all starts with vet visit growth. This metric is influenced by pet population growth and the average visits/pet/year. Vet visit growth ranged between +2%-3% each year prior to the pandemic. This coincided nicely with average pet ownership growth of +1%-2% annually. During the pandemic lockdowns, many new pets were adopted at a rate of +6% in 2020 and +4% in 2021 in the U.S. This resulted in visit growth for IDEXX increasing to +3.6% in 2020 and +7.8% in 2021. Most of the growth in visits were from 3Q 2020 to 2Q 2021.
Given that pet adoptions continued to grow at +2% in 2022 and at +1% in 2023, expectations heading into 2022 and 2023 for visit growth were for normalization (i.e. back to +2%-3%). However, IDEXX has experienced declines in visit growth of -2.2% in 2022 and -0.9% in 2023. Some of that was initially explained by the company as veterinary practices adjusting to the staffing shortage and increased cost of hiring. Even with a lot of those macro pressures abating, visit growth hasn’t yet returned.
The more likely explanation for the decline in vet visits could be that a weaker consumer spending environment is resulting in delays, especially on the wellness side, which tends to be a bit more discretionary. The company experienced that impact since the 2nd half of 2023. Another explanation could be that many of the new pet owners from the pandemic years were from a younger cohort of owners, which tend to have less discretionary income.
The next factor is diagnostic testing utilization. Historically, IDEXX has grown diagnostic utilization by 50bps per year, from 13% in 2010 to 19% in 2023. This is broken down into 11% for wellness and 25% for non-wellness visits. Every 50bps increase in diagnostic penetration in the U.S. results in a +1-1.5% boost to CAG recurring revenue growth.
Looking ahead there are a couple of reasons that we can expect this trend to continue. First is that veterinary practices make good money off diagnostics. In 2023, 17% of veterinary practice revenue and 28% of profits came from diagnostics. That’s because diagnostics have the highest margins at 45%. The second reason is that older cohorts of pets tend to require more diagnostics. For puppies and kittens, 1/3 of clinical visits included diagnostics and that number jumped to 50% for senior (7-11 years) and older cohorts. Given that there was a big increase in adoptions in 2020 and 2021, we should see that have a positive impact to diagnostic utilization in the near future.
Pricing is the third factor in determining organic revenue growth. Price increases are set by the company to capture some of the increased value IDEXX is providing its customers and to offset inflation. Historically price increases have ranged between +2%-3% but this ramped up to +5.3% in 2022, +7.8% in 2023 and +5% is expected for 2024. The company argues these increases are justified because veterinary practices set their own pricing for what is charged to the pet owner (usually 2x-3x mark-up). And pet owners on average are still keeping pet spending below 2% of their income (1.6% in 2021). IDEXX also argues that the company delivers more features and functionality each year like DecisionIQ included in VetConnect Plus at no extra cost as an example.
Looking ahead, the expected long-term drivers for CAG recurring revenue growth are +2.5%-4% price realization, +3.5%-4% for increases in diagnostic utilization, +2.5%-3% in installed base expansion and +3% growth in clinical visits. That equates to +11.5%-14% revenue growth for this segment. The company has been below these levels since 2021. To achieve these growth rates, clinical visits have to return to positive growth and utilization needs to improve from current trends. The long-term margin goal is to improve by 50-100bps annually due to 60+% incremental diagnostic margins, lab productivity gains, price increases and increasing software contribution.
Why is it a good business?
As the leading provider of diagnostic instruments and software to veterinary practices, IDEXX benefits from scale advantages and its customers’ increasing switching costs. The company is deeply integrated with its customers’ diagnostics workflow, whether they choose to use IDEXX’s SNAP rapid assay kits, diagnostics instruments or a reference lab. As the employees of veterinary practices get trained on and familiarize themselves with the company’s in-clinic diagnostic instruments, it’s increasingly more difficult to switch to another provider. This also applies to the IDEXX’s software offerings, which include practice management (ezyVet, Neo), order management (VetConnect Plus), customer engagement (Vello) and others.
This is evidenced by the company’s high retention rates. For the company’s diagnostics products, retention rates range 97%-99.5%. Consumables are the highest at 99.5% retention for 2022, reference labs were at 97.6% and SNAP at 97%. For IDEXX’s practice management software, net dollar retention rates are over 110%, similar to other good software businesses. Most of the company’s software placements are now cloud based and 2/3 of the installed base will be on one of IDEXX’s cloud offerings by 2025. This is a big step-up from 2020 when 1/4 of the installed base was cloud based.
The company also benefits from its large installed base of instruments. As of 2023, IDEXX had an installed base of 135k instruments (Catalyst 69k, ProCyte 48k and SediVue 18k) and the company expects this number to reach 330k units over time. This is up from just 29k instruments in 2013, which is a CAGR of +15% over the past 11 years. The company expects instrument placements to average 10%+ growth annually going forward, which implies the company should reach its target sometime in 2033.
Increasing the installed base on instruments matters because it leads to higher utilization of other offerings from IDEXX. The attach rate for customers that own the Catalyst instrument to the ProCyte instrument are over 80%. And this especially helps in certain international regions where the sales process leads with hematology products. We also see more customers that utilize both in-house and reference lab services. This statistic increased +100bps in the US, +300bps in Germany and +300bps in Spain in 2023.
Adoption of IDEXX’s software offerings by customers also results in more spending on diagnostics. Customers that switched over from a competing practice management software system to ezyVet on average increased their utilization of IDEXX’s diagnostics products by 17% after one year. And customers that switch to ezyVet tend to also adopt other digital offerings from IDEXX like Vello, VetRadar and SmartFlow.
For scale advantages, IDEXX’s reference labs can run tests at a lower cost than competitors due to the increased density in certain regions and the higher number of tests that run through the company’s network. As the company has scaled, IDEXX was also able to benefit from investing in its own commercial sales force starting in 2015 rather than selling through distributors. The company now has 1.2k field-based professionals (up from ~600 in 2019), which allows them to better service their customers’ needs.
Returns on incremental capital?
Over the past 10 years, IDEXX has spent 38% of its capital on capex, 51% on R&D and 11% on M&A. Capex is mainly related to diagnostics equipment for the company’s reference labs, manufacturing facilities and capitalized software development. Capex has ranged steadily between 4%-6% of revenues and each of its three segments have similar levels of capital intensity.
R&D is the main driver of capital investment at IDEXX. The company has invested over $2B in R&D since 1998. Of that, 70%-80% has been for new product development and 20%-30% for existing products, specifically for improvements resulting in greater efficiency and ease of use. R&D can be further broken down for advancing its instrument platform (40% of total R&D spend since 1998), assay developments (30%) and software development (30%).
Instrument platform development is related to improving existing instrument lines like the Catalyst One (2014 release) vs. the existing Catalyst Dx analyzer (2008 release) as an example. The Catalyst One has a smaller form-factor and is 40% cheaper to manufacture. Customers can’t run the same number of samples simultaneously and is restricted from a small panel of tests. However, for most veterinary clinics, the Catalyst One is much more suitable. Instrument development can also be related to new lines of diagnostics. The inVue Dx Cellular analyzer, which is expected to be released in late 2024, is a new line of instruments that can run cytology and blood morphology tests.
Assay developments are related to developing new reference lab tests and improving existing tests for increased usability and reliability. For example, IDEXX recently improved its Fecal antigen panel to include testing for Cystoisospora and tapeworms. And the company also included Cystatin B as a kidney marker to the urine panel. IDEXX also improved its SNAP 4Dx Plus test (originally launched in 2006), which tests for the common seven vector-borne diseases, to improve sensitivity and earlier detection.
For M&A, the company makes opportunistic purchases of independent reference labs and complementary software. The largest recent acquisition for IDEXX was in 2021, when the company acquired ezyVet for $157.2M. This was a great acquisition for the company since ezyVet was already integrated at many of the larger networks of veterinary clinics and it complemented IDEXX’s Neo software for smaller clinics. While the terms of the acquisition were not disclosed, we know that ezyVet was guided to contribute $15M in revenues in 2021 and the acquisition closed in June. Assuming a $30M revenue number for 2021, the acquisition multiple was 5.2x revenues.
The company also acquires reference labs from time to time to build out its network of labs around the world. In 2021, IDEXX acquired a lab in Finland for $13.4M and Switzerland for $5.5M. In 2019, IDEXX acquired a multi-site reference lab in the mid-west U.S. for $50M.
In 2024, the company acquired Greenline Pet, which allows for coupon and rebate redemptions for manufacturers in the animal health and nutrition sectors. These rebate programs allow manufacturers to target potential customers and is integrated with practice management systems of veterinary clinics. This helps clinics to have more contact points with pet owners while making care more affordable.
We estimate that IDEXX generated returns on incremental capital between 25%-45% over the past 5 years. This does include the slowdown in vet visits after the Covid related boost in pet ownership in 2020 and 2021. We have to remember that while IDEXX has experienced lower than expected visit growth starting in 2022, their organic revenue growth still remained positive due to increased penetration in diagnostics and price increases to offset inflation. Looking ahead, returns on incremental capital look to rebound when pet visit growth begins to normalize. The pet adoptions during the pandemic moving into the older cohorts should also help.
Reinvestment potential?
IDEXX estimates that worldwide TAM is $45B, of which $17B is US, $7B Latam, $14B Europe and $7B APAC. The company arrives at this calculation based on:
the number of pets visits * the split between wellness/non-wellness visits * the % of visits which is optimal for diagnostics inclusion * implied revenue/visit for diagnostics
This formula implies that increasing the % of visits up to an “optimal level” would be a big driver for reaching that TAM over time. One way to increase that number would be to increase the company’s installed base of instruments to as many clinics that would benefit. And to increase the number of instrument placements, IDEXX has ramped up its commercial sales force in recent years and have worked with veterinary practices to make taking on new instruments with the least amount of financial friction. IDEXX doesn’t require many clinics to pay up front for their instruments, but rather commit to a certain amount of testing volumes over many years. The company expects that the instrument placement opportunity for Catalyst is 77k (up from 69K in 2023), ProCyte is 94k (up from 48k), SediVue is 70k (up from 18k), and inVue is 90k.
The company also views cancer diagnosis as a big near-term opportunity with a TAM of $2.5B. The new cancer panel launching in 2025 would be able to identify specific markers and cancer types earlier than before. At launch, the panel will detect lymphoma and the company plans on adding screening capabilities for 5 additional cancer types in subsequent years.
International is also a large opportunity for IDEXX to capture more market share and increase the penetration of diagnostics. The U.S. is the largest market for pet healthcare but the benefit of diagnostics in international veterinary clinics is starting to be recognized. In 2020, it was estimated that the average U.S. practice generated diagnostics revenue of $79k/year, higher than the next 13 top revenue generating countries combined. Some of that disparity is due to how often pets are taken in for routine diagnostics tests and the pricing of those tests. Just some rough numbers for 2023 suggests that in the U.S., a wellness diagnostic costs about $80 and a non-wellness diagnostic costs about $115. The numbers are lower internationally. Certain international markets are also heavily skewed towards hematology testing so the success of the ProCyte One should allow IDEXX to cross sell other instruments and tests.
Tailwinds that are helping the industry grow over time are the increasing pet population, lengthening of the average lifespan of pets and shift in the mix of breeds. At least in the U.S., the pet population continues to grow each year even after the surge in 2020/2021. Pets are living longer, with the average lifespan of dogs increasing from 11.6 years in 2010 to 13 years in 2023. Cats are following a similar trend increasing from 12.3 years in 2010 to 14.2 years in 2023. As pets age, average diagnostics revenues increases, up from $45/year at a puppy to $130/year as a senior (8-11 years) and $150/year for pets older than 11 years. Dog breeds that are in favor in recent years are french bulldogs, golden retrievers and labradoodles, which have a much higher diagnostic spend rate.
With a reinvestment rate between 30%-40% and a return on incremental capital between 25%-45%, we estimate that IDEXX has increased its intrinsic value between 10%-13% over the past 5 years. While pet visit growth has underperformed the past couple of years, the company has been able to offset that decline with higher than historical price increases. As IDEXX releases new instruments and test panels and invests to increase diagnostic utilization (especially internationally), we should see consistent reinvestment rates going forward.
What else is important?
Waiting for vet visits to return to growth
The main issue with IDEXX is that vet visits have declined even though pet adoptions spiked during the pandemic. The company first explained it as staffing issues, but it’s become evident that the macro environment has impacted pet visits, especially on the wellness side. Looking back to the initial covid lockdowns in March to May of 2020, we see that wellness visits took a big dip (though it wasn’t all macro related) down -28% y/y in April vs. just -10% y/y for non-wellness.
In 2008/2009, we can see that personal consumption expenditure for pets saw a similar decline to the dip in 2020 and in this case the impact was mainly from consumers worrying about their financial state. Spending on pets quickly rebounded to normalized levels in subsequent years. In 2022/2023, pet visits have ranged between flat to -2% for non-wellness visits and -1%-3% for wellness visits. In IDEXX’s 2024 Pet Parent Survey, 4% of respondents said they delayed a sick visit and 12% responded they delayed a wellness visit. However, this is still much lower than 21% that responded they delayed or canceled travel plans and 44% that responded they reduced eating out.
Optionality
Most of the optionality for IDEXX is to introduce new panels or instruments to expand horizontally among their installed base of veterinary practices. Software does also present upside to capture more of their customers’ spend but I’d argue that software helps more to solidify the company’s lead within diagnostics than acting as another avenue for outsized growth. If you look at IDEXX’s software revenues over the past 10 years, it’s grown under the rate of the overall company since consumables and reference lab testing revenues have grown at a much faster rate.
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can you show math of your ROIIC calc? Thanks!