Profiting from Pet Care

"Man's best friend" could turn out to be one of your best investments, too. The numbers tell the story: Pet care is a high-growth industry.

More than 60 percent of US households report an animal in residence. About 46 million US families own at least one dog, with 40 million reporting that they own cats. Not only are dogs and cats good company, but years of research show that pets convey health benefits, with owners reporting lower blood pressure, less anxiety and higher immunity to illness.

But pets aren't cheap. Aside from the obvious cost of purchasing the animals they also need to eat, play and have their own health issues addressed, costing Americans an estimated $55.53 billion last year. That price tag has been steadily rising for more than a decade, as an ever-growing number of households call at least one animal "family."

According to data from the American Pet Products Association, Americans spent an estimated $21.26 billion feeding Fluffy and Fido last year and another $4.54 billion on services such as grooming and boarding. Purchases of the animals themselves ran to about $2.3 billion.

The biggest expense associated with pet ownership is (you guessed it): health care.

Last year, US expenditures for vet care and medicines came in at $27.42 billion. That's sparked a great deal of interest in animal health among the world's leading pharmaceutical companies. Merck (NYSE: MRK) is reportedly interested in purchasing Novartis' (NYSE: NVS) animal health operations and last year Pfizer (NYSE: PFE) spun its own animal health unit out into a freestanding company, Zoetis (NYSE: ZTS). That huge chunk of spending is also attracting entirely ! new entrants into the animal health market.

Kindred Biosciences (NSDQ: KIN), a development stage animal biotech, last December completed its initial public offering (IPO) and raised $40 million, netting about $36 million. To shorten development times and boost approval rates, the company is working to develop animal therapies based on those that are already used on humans.

By focusing on already successful human treatments, the company should be able to move from concept to marketing approval in just a fraction of the time it normally takes. Bringing a human drug to market can take five years or more, but by using already approved drugs Kindred should be able to secure animal approval in only two years. That would allow Kindred to stuff its development pipeline with potentially promising animal drugs at a much lower cost than companies developing new drugs from scratch.

The company already has 10 molecules (5 small molecules and 5 biologics) in development for 13 indications ranging from immune diseases to cancer. It already anticipates filing new drug applications for two drugs in three indications this year: CereKin for osteoarthritis pain in dogs and horses and AtoKin for the treatment of atopic dermatitis in dogs.

A third molecule, StentiKin for the treatment of postoperative pain in dogs and horses, will likely come up for a new animal drug filing in early 2015.

Kindred expects to spend about $15 million of the cash it raised to complete the development of those three drugs; if the drugs were for human indications the total development cost would be in the hundreds of millions. The rest of the cash is slated for the development of its commercial network in the US and to move its remaining molecules through the development process.

In the third quarter of 2013 (the final quarter before the IPO), the company had about $11 million in cash on its balance sheet. In the three quarters so far that year, it burned just $1.8 million with $1.4 million spent on resear! ch and de! velopment and $400,000 on general and administrative expenses. At that burn rate, post-IPO the company can fund itself for at least another 5 years.

The company is already attracting a great deal of attention. Just a few weeks after its IPO the Baupost Group, a hedge fund with about $30 billion in assets, reported that it purchased almost 3 million shares at $11.17 for a 17.9 percent passive stake in the company. With shares currently trading at $22, the fund has already more than doubled its money.

Granted, the animal health space is becoming somewhat crowded. But animal health is nowhere near as saturated as human health and Kindred's current slate of just three candidates coming up for approvals is estimated to be worth between $4 billion and $5 billion in annual revenues. For now, there's still plenty of money to go around and ample time for the companies to differentiate themselves.

Kindred Biosciences is a great buy up to 30.