The lockdown-driven boom in pet ownership has caused a surge in sales for companies catering to the needs of our household companions. For Dechra Pharmaceuticals [LON:DPH], the leading UK manufacturer of animal-health medicines, prospects continue to look bright.
On 30 August 2022, the company unveiled one of its largest acquisitions to date of leading veterinary pharmaceutical manufacturer Med-Pharmex for a total consideration of £221.5 million.
With Med-Pharmex based in Pomona, California, this acquisition (one of a number in recent years for Dechra Pharmaceuticals) will provide further scale to Dechra’s operations in the US, where Dechra generates 36% of its revenues. Additionally, 75% of Med-Pharmex revenues are related to pets and equine products, which will further bolster Dechra’s portfolio in the lucrative ‘companion animal’ segment. In 2021, Med-Pharmex generated revenues of US$43.0 million and adjusted EBITDA of US$15.3 million. Therefore, this acquisition will result in accretive earnings to Dechra’s bottom line.
In Dechra’s August market update, the company detailed that the majority of Med-Pharmex’s revenue is currently derived from the sale of white label products to veterinary distributors. Dechra plans to bring some of these white label products in-house and sell them through its already established sales and marketing channels, which will enable Dechra to find value-enhancing synergies.
The Chief Executive Officer at Dechra Ian Page commented, “I am delighted that we have completed the acquisition of Med-Pharmex, a company that I have been in dialogue with for a number of years. The US market is highly consolidated; therefore, this is a unique opportunity to add several new products to our portfolio, enter the US FAP [food animal products] market and improve the manufacturing footprint for our North American business.”
Even prior to announcing this acquisition, results for 2022 looked promising for Dechra Pharmaceuticals. In Dechra’s financial year ending June 2022 results, the company saw overall revenue growth of 14%, which was driven by strong growth in North America of 24% for the period. Growth during the year has been mostly organic, as a number of Dechra’s companion animal therapies have been in strong demand and the return of face-to-face visits for Dechra’s sales team has helped to drive uptake of Dechra’s portfolio of medicines.
A perfect market environment for Dechra Pharmaceuticals to scale into…
Its no secret that Dechra Pharmaceuticals has been executing flawlessly for several years. The business has enjoyed annual growth averaging 13% since 2017, with earnings per share growing at 14% annually over the same period. Despite a challenging global environment, gross margins have held steady at 57%, buoyed by the highly profitable companion animal business, where gross margins exceed 70%.
However, despite solid results in recent years, Dechra’s growth prospects remain attractive. As highlighted in Dechra’s annual report, the business remains in an enviable position compared to its industry peers, as it has only a small slice of the total animal pharmaceuticals market by revenue. Dechra’s business model thrives on small bolt-on acquisitions and purchasing the rights to medications initially produced by bigger players. As the larger animal health companies optimise their large product portfolios, Dechra can then acquire the rights to existing compounds at attractive prices. In the first half of 2022, Dechra Pharmaceuticals acquired two products from Elanco to bolster their anaesthesia and analgesia portfolio.
Unlike human pharma, which faces steep price erosion on legacy drugs from generics companies, animal health companies typically have a larger number of products with smaller market sizes and thus legacy products tend to not be as heavily affected by generic competition. In addition to this, pricing pressure in animal health is also reduced, with a much more fragmented customer base (80% of US veterinary practices are independent) and little presence of large ‘payor’ bodies such as the NHS that drive prices lower through rigorous pricing reviews.
All the above means that for Dechra, investing in small bolt-on acquisitions and purchasing the rights to existing medications should prove successful in the long run, as both strategies allow the business to access new markets and drive cost synergies across the group.
With acquisitions being a core part of Dechra’s strategy to drive market share growth over the long term, below we have outlined Dechra’s recent acquisitions and its source of funds to investigate the sustainability of such a strategy.
*The £221.5 million acquisition of Med-Pharmex has been included in FY 2022 estimates. This may or may not be included in the company final accounts as of September 2022 depending on the timing of cash payment to Med-Pharmex shareholders.
As you can see from the above table, acquisitions for Dechra Pharmaceuticalshave averaged £150 million over the last five years, with the largest value being the recent £221.5 million purchase of Med-Pharmex. Given Dechra’s current market cap of over £4 billion, Dechra’s capital allocation seems appropriate. The company has funded acquisitions primarily through additional debt borrowing and share issuance, as net cash flow has typically fallen short of acquisition values each year.
Whilst share issuance is not always ideal for stock owners, the company is set to have issued £419 million of share capital in the five years to 2022, which is just over 10% of current market cap. Despite borrowing an average of £200 million each year, strong cash conversion has resulted in Dechra exhibiting a robust leverage ratio of just 0.9x net debt to EBITDA as of HY 2022.
What is clear from the above table is that Dechra hasn’t struggled to identify bolt-on acquisitions, whether this has been through purchasing the rights to products or acquiring whole entities. Given the sensible use of a mix of cash flow, debt and share issuance, Dechra’s acquisitive strategy looks to be sustainable for years to come.
Operating in a favourable market with multi-year tailwinds and executing well against a sound strategy, Dechra’s shares don’t come cheap. Even after a 30% fall in the shares this year, the company trades on a valuation of 50x anticipated earnings in 2022. Optimists would argue that the shares have rarely traded below a P/E of 40 for the last decade, and the business is highly resilient to an impending downturn in the global economy. However, we view the current multiple as a touch too high even for such a great business. Dechra remains on the watchlist for now.