Dechra – good, but not that good
Posted on April 23, 2008 by Richard Beddard
Filed Under Companies |
Every good growth story has a price attached. Veterinary supplies and pharmaceuticals company Dechra has a good growth story, but it’s not that good.
Today’s iBall is Dechra Pharmaceuticals (DPH). I picked it because it’s mixing it with mining and farming companies near the top of the performance table*1. Its price may only have risen 20% in a year, but it was a year in which most shares fell.
The premise of momentum investing is that recent price rises will repeat in the immediate future. That may happen, but here, I’d like to look a bit further ahead.
Dechra is two things. It’s a wholesaler of veterinary supplies, everything from computer systems, to drugs, and laboratory services. And it develops prescription drugs for dogs, cats and horses.
The good
I can see why it’s popular with investors. Its customers aren’t debt-ridden consumers, but vets. Some of its customers’ customers are consumers, but others are farmers who are faring better than they were. Economic growth has slowed, and may slow further, but pet owners love their pets - sometimes more than other people, so perhaps veterinary bills won’t be the first they seek to cut.
Then there’s Dechra’s split personality, which may be Jekyll and Jekyll, rather than Jekyll and Hyde. The bigger supplies business is a monopoly – it has 44% of the UK market. But drugs are more profitable, and growing fast (25% earnings growth last year, overall the company grew 16%).
Taking the PEG ratio as a guide, Dechra would have to grow profits at an annual rate equal to its price earnings ratio to justify its share price. Its PE is around 23 (or 19 based on next year’s consensus). Analysts reckon Dechra will grow about 17% a year for the next three years.
Since its achieved similar growth rates in four of the last six years, these targets seem possible.
The uncertain
Achieving them is not simply a matter of replicating earlier successes, though. Dechra is increasingly focussing on the USA and Europe. Last year it bought VetXX a Danish company for £30m and £326m Danish Kroner (about £65m). It bolstered its five strong US office when it bought the rights to a range of veterinary products.
Dechra aims to rollout its drugs through its new foreign subsidiaries, which is exciting because the markets are so big. But it’s also risky. Last year it only took £6m in sales from customers abroad compared to £248m in the UK.
A Dechra expands, integrating companies and products, facing new regulators, and new competitors, there are bound to be setbacks.
There are other risks too. In the UK, new corporate veterinary practices have more buying power. I can’t find much about its drug development pipeline, which the company says is commercially sensitive, but a healthy pipeline is important for growth.
And Dechra may be resistant to recession, but it’s not immune. It lists ‘general economic conditions’ as a risk in its 2007 annual report.
Our past experience has been that these slowdowns have been short term in nature. However, given the relatively high operational gearing of NVS [National Veterinary Supplies], in particular, any future market slowdown could have a material effect on short term profitability.
Which happened when, between January 2001 and early 2003, a Competition Commission inquiry, foot and mouth, depressed agricultural markets, and a 13% contraction in profits in 2002, collapsed the share price from over £2 to under 50p.
The conclusion
Recently Deborah, a financial blogger, described growth companies as:
the worst example of counting money before it is earned…
The more you pay for a share, the higher the return you expect. I fear, at approaching £4.00 and over 20 times earnings, Dechra investors are expecting a bit too much, which means another way to board the Dechra growth train is to wait and see if it derails again. History shows derailings can be wonderful opportunities.
Footnotes:
- A table I keep of well-established stocks with more than five years of earnings.
- In checking the definition of operational gearing at the indispensible Money Terms site, I noticed that Graeme’s put up a section on analysing pharmaceutical companies.
- If I were superstitious, I’d believe the Dechra van I saw parked at the veterinary practice opposite the station I commute from this morning (pictured at the top of this article) was a good omen. I’m not superstitious
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Hi Richard,
I loved Italy when I visited in 2005.
Thanks for the quote.
Deborah