The week has started disappointingly for shareholders in Dechra Pharmaceuticals (LSE: DPH). Shares are down around 15% in Monday morning trading, as I write, meaning they have lost 36% of their value over the past year. Why has the Dechra Pharmaceuticals share price fallen so sharply – and could now be the moment to add the firm to my portfolio?
How to value shares
Essentially, there are two elements to share price valuation. The first is what a business’s financial prospects objectively are. Over time that becomes clearer, but it is never entirely obvious as nobody can predict the future.
The second element is how investors assess those prospects. That is more subjective. Bullish investors may think a company deserves a share premium because of its strong growth outlook. Others may feel the shares ought to be priced lower to reflect risks they perceive.
Over time as a company matures, there is often more widespread agreement among investors about its outlook and therefore its valuation. As billionaire investor Warren Buffett says, in the short term the market is a voting machine, but in the long term it is a weighing machine.
Growing pains
I think that is what has been happening at Dechra as it matures.
The underlying business looks attractive to me. The company operates in an area I expect to see resilient demand, namely animal nutrition. Its brands, technology and distribution network give it a competitive advantage that can be turned into pricing power.
It has been consistently profitable and last year earned £58m after tax. Revenues grew by 12%. That is very creditable — but it is not the sort of huge growth rate associated with some early-stage companies.
However, for a long time Dechra has traded on the sort of price-to-earnings ratio associated with high growth businesses. I think an ongoing investor reassessment of whether it deserves such a valuation lies behind the price fall, rather than any dramatic step down in the worth of the underlying business.
Disappointing interim results
That said, today’s price action follows this morning’s release of the company’s interim results. Year-on-year, operating profit fell 22%, diluted earnings per share were down 47% and operating cash generating before interest and taxation fell 36%. Net debt more than doubled to £423m. That all sounds terrible.
The company has been changing to running its own sales and marketing operation in Korea. That dragged down earnings. There are other risks to future earnings, such as cost inflation hurting profit margins. The operating margin in the period fell heavily, from 28.2% to 23.9%.
But I still think the results demonstrate some of the positive aspects of Dechra’s business. Revenues were up 13.5% compared to the same period last year, albeit helped by exchange rate movements. While operating profit fell, it still came it at £44m. The dividend was increased 4.2%.
Tumbling share price
Previously, the company was priced for perfection. As its latest results show, business performance is far from perfect.
But even after halving from where they started last year, I still think Dechra shares look pricy. They trade for over 50 times last year’s earnings after tax – and today’s announcement makes me think earnings may well fall this year.
So despite the tumbling share price, I am not ready to buy yet.
The post What’s going on with the Dechra Pharmaceuticals share price? appeared first on The Motley Fool UK.
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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.