Margins squeezed in Dechra's Services business

Veterinary pharmaceutical firm Dechra Pharmaceuticals saw a slight fall in interim pre-tax profits and a softening of gross margins in its Services division in the second half of 2011.

Profit before tax in the six months to December 31st 2011 dropped to £8.9m from £9m the year before, on revenues of £209.5m compared to £192m for the same period the previous year.

The services sector achieved a 7.3% increase in revenue compared to the corresponding period last year, which was partly due to the soft comparison with the corresponding weather-affected period, but also due to some market recovery. The margin took a hit because of a rise in discounting in a highly competitive market, especially from online competitors, the firm said.

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The Services division's operating margin slipped nine-tenths of a percentage point (90 basis points) to 3.4%, but this erosion was largely offset by a 190 basis points improvement in the Pharmaceutical operating margin (pre-research and development costs) to 26.2%.

The interim dividend rose from 3.70p to 4.10p year-on-year.

In a statement the company said: "Trading within our veterinary product segment, the main area of our strategic focus, continues to perform robustly. We remain well positioned to maintain strong growth by continued organic growth of existing products, expansion into new territories and the introduction of new products.

"The overall economic environment will continue to pose challenges, especially in our Services segment, however overall market growth continues to exceed pre-year expectations."

Broker Panmure Gordon, which rates the shares as a "hold", said the numbers were in line with expectations.

"With the company being in an investment cycle for growth in the US, we believe the share price upside is capped for the time being until investors get better visibility of the how fast the company is achieving growth in the US," said Panmure Gordon analyst Savvas Neophytou.

Peel Hunt is another broker sitting on the fence. While it concedes the results confirmed "decent top-line growth of 9% (helped by acquisitions and currencies)" the pressure on margins in its key Services division, which accounts for three-quarters of revenues, "offsets the potential for profit upgrades (yet again)."

Peel Hunt's Dr Stefan Hamill sees better vale elsewhere in the sector, identifying drug inhaling device maker Consort Medical as a better pick.

"With £46m net debt, Dechra has a little headroom to pursue further small acquisitions in the rest of the year, but limited scope to pursue a more chunky deal akin to the Dermapet deal in 2010," Dr Hamill noted.

finnCap's Keith Redpath remains a buyer of the stock, however, and is sticking with his full year forecasts. "The second half of Dechra's financial year is generally one of strong cash inflow, consequently we would anticipate a significant reduction in net debt from the current £46.1m by year end," Redpath said. The broker has a 620p target price for the stock.

WH Ireland is somewhere between the holders and the buyers, with an "out-perform" rating on the stock. It has trimmed its top of the market range pre-tax profit forecast by 4% to £33.6m from its previous estimate of £35m, but notes that a better tax position will see this reduction offset on the bottom line. WH Ireland forecasts full year earnings per share of 38.0p.

The broker's sum of the parts and discounted cash flow derived valuation models place a fair value of 600p on the shares.

The share price dropped 0.97% to 564.00p by 12:07.

NR