When does a pet become more valuable than a human? Answer: when the City assigns a higher rating to a veterinary science group such as Dechra than to a leading drugmaker like Glaxo. Is this premium justified? Let’s have a look.
Dechra Pharmaceuticals (LSE:DPH), rated as a BUY by WH Ireland
Stoke-on-Trent-based Dechra is forecast to deliver turnover of around £350m this year from its two main units. The higher margin (20%) pharmaceuticals unit develops its own prescription medicines (eg, anti-inflammatories) for dogs, cats and horses, and licenses in other animal treatments (such as diet food and shampoos) from third parties. An important point to make in terms of intellectual property is that Dechra tends not to own the underlying patent as it develops most of its drugs from science that has already been discovered. This cuts investment on research, but means there is a greater threat of copycat treatments.
The second division is services, which accounts for about 80% of revenues but only generates 4% profit margins. It is essentially a full-line wholesaler supplying veterinary practices with more than 14,000 products, including medicines, consumables and accessories. It is a good cash generator and relatively defensive in nature – the UK pet market is estimated to be worth around £10bn a year and growing at a 5%-10% annual clip.
But investors should not be lulled into a false sense of security. There have been times when growth has dipped, such as during the BSE and foot-and-mouth scares. And in harsher days, even pet owners cut back on items such as new squeaky toys for Fido to chew.
With this in mind, what do I think Dechra is worth on a sum-of-the-parts basis? I would put the more technology-heavy pharmaceutical unit on a 14-times earnings before interest and tax multiple, generating a fair value of around £150m. I would rate services at eight times operating profits, or £85m. So after deducting net debt of £27m and central costs of £2.3m a year, the whole shebang is worth around 280p a share – 30% less than today.
So why has the City got it so wrong? Probably for three main reasons. Firstly, Dechra has a scarcity value since it is one of the only listed vet stocks. Next, it is seen as recession proof and so has become an expensive ‘safe haven’ as cautious investors have bid up the price. Finally, many analysts are very bullish on its canine treatment for Cushing’s disease – Vetoryl – and reckon it will become a blockbuster after its recent launch in America. This rose-tinted view may be right, but I suspect reality will be rather different. At more than 17 times forward earnings, the shares appear priced to perfection, so any minor disappointments will come as a big shock. And even if Vetoryl does hit its stretching targets, then I’m sure rival products will be launched quickly thereafter.
All told, although Dechra is a quality business operating in an attractive sector, I believe the stock is overbought and now vulnerable to a brisk hair-cut. Investors should also note that the company has to refinance around £21m of loans within the next six months – not a straight-forward task, given the dire state of bank lending.
Recommendation: SELL at 426p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.