Dechra counts the blessings of specialisation

Like most companies faced with an extraordinary situation, Dechra Pharmaceuticals (DPH) had to improvise as the pandemic hit supply chains and forced up manufacturing and distribution costs at a time when the company saw much greater demand than normal for its veterinary medicine products. That might be related to more companion pets being purchased to offset the loneliness of the lockdowns, but it certainly spurred the business on despite the cost pressures observed over the past 18 months. However, the company, which specialises in animal care pharmaceuticals, saw a return to more normal business during the half, with demand and margins moving towards historic averages. That left many observers wondering whether the company can maintain momentum after the effects of the pandemic eventually subside.

Dechra’s generally high operational gearing meant that increased sales fed through quickly to operating profits and margins increased by an underlying 120 basis points to 28.2 per cent. Most of that was generated by the CAP segment of the business, which saw revenues increase by 17 per cent at constant currency to £245m after strong demand in the US spurred by a recent spate of product acquisitions. Management also said that the acquisition into its European business Osurnia, in particular, were contributing in line with expectations, with £2m of revenues booked in July.

The balance sheet also pointed to reasonable levels of growth this year, with key forward sales metrics such as receivables staying broadly stable year on year. The key point for Dechra is whether it will be able maintain margin expansion into next year in order to take its return on capital employed (ROCE) above 20 per cent, which would be going on for the highest level of ROCE return in 15 years.

In terms of long-term growth and dividends, Dechra’s record is hard to beat over the past 20 years, particularly as the business has evolved from a heavy reliance on its equine medicines’ portfolio into a much more mature and diversified company. Unfortunately, unless investors were agile enough to pick up the shares during the initial pandemic slump in March 2020, that quality is more than amply reflected in the current forward price/earnings ratio of 34 times broker Numis’s forecasts for this year. That looks very rich considering that earnings have eased back from a high base, along with the share price. Always a company to watch but be prepared to be patient and wait for a better entry point. Hold.

Last IC View: Hold, 4,906p, 6 Sep 2021