Investors rarely like to see large parts of a company sold off to finance future expansion; it often looks like sacrificing security for an intangible future benefit. However, in the case of animal pharmaceutical specialist Dechra Pharmaceuticals (DPH), there are firm grounds to believe that the £87.5m disposal of its veterinary services business will generate much better returns for investors in the long term.
- Services business sold
- Business looks more focused
- Better returns on capital forecast
- More attractive to acquirers
- Still has to break into US
- Needs a fuller product pipeline
The services business had made up about 70 per cent of Dechra's revenues, but only about a quarter of its profits and was a leftover from the company's earlier incarnation as a straightforward veterinary supplies company. There had been talk, indeed criticism, for some time that the low-margin business was inhibiting the development of Dechra's more profitable pharmaceutical operations, based around its Vetoryl treatment for Cushing's disease, which afflicts horses and dogs.
So the sale to US company Patterson was not an overwhelming surprise in the context of management's long-term plans. Indeed, Dechra has been focused on growing its position in the pharmaceuticals and pet products markets in Europe and the US. For example, the company made a big acquisition last year of European company Eurovet Animal Health for €135m.
The most immediate tangible effect of selling off services will be on the return that Dechra generates on the capital it employs. According to Investec research, return on capital employed reached a low of 12.8 per cent in 2012, but jettisoning services should boost this to 17.4 per cent this year and 22 per cent in 2014, as the company nails down its cost base and concentrates solely on manufacturing rather than distribution and logistics.
The other important point is that it allows management to focus on improving the pharmaceutical business. Arguably, this has drifted somewhat recently with a combination of production problems in the US and regulatory delays clipping sales growth. Indeed, the 19 per cent fourth-quarter growth reported earlier this month was a shade lower than expected. The delays have been caused by the fact that new production of its ophthalmic range has to be certified by the Food and Drug Administration before sales return to normal. Not having to manage two fundamentally different businesses should allow management to focus on pushing things forward.
DECHRA PHARMACEUTICALS | ||||
|---|---|---|---|---|
| ORD PRICE: | 682p | MARKET VALUE: | £595m | |
| TOUCH: | 682-686p | 12-MONTH HIGH: | 791p | LOW: 473p |
| FWD DIVIDEND YIELD: | 2.5% | FWD PE RATIO: | 19 | |
| NET ASSET VALUE: | 184p | NET DEBT: | 64% | |
| Year to 30 Jun | Turnover (£m) | Pre-tax profit (£m)* | Earnings per share (p)* | Dividend per share (p) |
|---|---|---|---|---|
| 2011 | 389 | 30.1 | 31.5 | 11.1 |
| 2012 | 426 | 33.0 | 32.4 | 12.3 |
| 2013** | 509 | 44.8 | 38.4 | 14.1 |
| 2014** | 213 | 38.8 | 32.6 | 15.5 |
| 2015** | 199 | 42.6 | 35.9 | 17.1 |
| % change | -7 | +10 | +10 | +10 |
Normal market size: 500 Matched bargain trading Beta: 0.09 *Underlying PBT and EPS figures **Investec Securities estimates | ||||
Getting the business back to meaningful growth is therefore a high priority and the proceeds from the sale will go a long way towards achieving this by effectively wiping out the company's debts. Investec believes the pro forma 2013 year-end balance sheet is actually likely to show net cash. The de-gearing of the balance sheet gives the company more room for making bolt-on acquisitions and it has a revolving credit facility of £65m on which it can draw. As well as being an acquirer, the removal of its low-margin services operation also makes Dechra a more straightforward potential takeover target for the sector's larger animal health companies.
The negatives with Dechra relate to how it will grow the pharmaceuticals business in the US. It has faced problems in the past with legal copies of Vetoryl being sold through dispensaries. In addition, it could be 2015 by the time the regulatory process and manufacturing issues associated with its delayed products have been resolved.
