Devro and the question of pricing power

It’s not known if Devro’s (DVO) management spends much time pondering the price elasticity of sausages, but results from its mature markets suggest that demand is holding up well despite wider cost increases. Devro is the world’s leading suppliers of collagen casings for food with manufacturing sites in the US, Netherlands, UK, China, Czech Republic and Australia.

The scope may be international but so is the input-price inflation that is putting the squeeze on household budgets. The group’s statutory half-year figures detail a 320 basis point decline in the operating margin to 14.3 per cent, although the rate stands at 15.6 per cent on a constant currency basis.

That’s still represents a marked decline and it seems at odds with the group’s expectation that it will fully recover inflationary rises over the full year on the back of targeted price increases. However, management asserts that the timing of cost pass-through to customers helps to explain why profits have lagged revenue growth, along with increased expenditure to expand the product base and a one-off expense linked to an industry-wide conference in Germany. There was also £1.8mn in adverse currency translations relating to the non-repeat of £2.9mn in hedging gains from the first half of 2021.

Shareholders can take heart from the 4.5 per cent sales volume increase and the performance of the group in its established markets, up by 7.6 per cent over the period. At 10 times consensus earnings, the valuation is hardly stretched, especially given the 5 per cent forward yield, but it would be prudent to see if the positive impact of cost pass-through will be more evident in the second half of 2022. Hold.

Last IC View: Hold, 184p, 10 Mar 2021