Shareholders in Dechra Pharmaceuticals (LSE: DPH) have had a rewarding year. The Dechra Pharmaceuticals share price has risen two-thirds in the past 12 months. It reached a new all-time high this month.
But can the ascent continue or is a price correction due? I see the Dechra share price as overvalued. Here’s why.
Strong business results
Dechra is focussed on producing pharmaceuticals for veterinary purposes. It produces drugs that help combat specific diseases in cats and dogs. That can be a lucrative business; there is consistent demand and like other pharmaceutical manufacturers, Dechra can use its intellectual property to attain pricing power. Last year, sales rose 7% to £515m and profits increased 10% to £34m.
In a trading update last month, the company announced that it expects to post an 18% jump in revenue for the most recent financial year. I think that is impressive. Clearly Dechra has developed a successful approach to growing its sales in the past few years. I also like its business strategy. Focussing on animal pharmaceuticals allows it to build a strong reputation with customers who are willing to spend what it takes to improve their animals’ health.
Growth potential
I think there is continued growth potential for the company. Its latest trading update shows that it has the wind in its sails, both in Europe and North America. As sales continue to grow, economies of scale ought to improve. That could be good for profits.
Dechra’s management has done an excellent job in growing the company from a small local animal pharmaceutical maker to a sizeable multinational operation. Management succession is a key risk, in my opinion. The company has benefitted from outstanding executive talent and it could be hard to find equally strong replacements in future.
Dechra Pharmaceuticals share price valuation
While I like the business, I do see a risk in the Dechra share price. A market capitalisation of £5.7bn is over 10 times sales. The price-to-earnings ratio is 57, which seems excessive to me. That means that at the current earnings level, it would take 57 years for the company’s accumulated profits to match its current enterprise value.
A bullish approach to this might say that the high price-to-earnings ratio reflects the possibility of future earnings growth. But recall that last year, profits grew at 7%. That is good, but I don’t think it is stellar. Admittedly earnings growth could accelerate, just as revenue growth has been doing. Nonetheless, I don’t think that justifies the large price tag.
I’m not attracted by the Dechra share price
While I like the Dechra business, I do not plan to buy its shares for my portfolio. To me, they currently look expensive. If the company grows earnings strongly each year for the next few years, I think it could grow into the current valuation.
But that is as yet unproven, and there is a lot of work to be done to maintain strong earnings growth. If there is even mildly disappointing earnings news at any point, I think the Dechra Pharmaceuticals share price could suffer.
