Investing in the pharmaceutical industry can be a bit of a hit or miss exercise for retailer investors. While companies in the sector can enjoy sky-high margins and years of protected revenue thanks to patents, their share prices can also fluctuate wildly based on poor clinical trial results or a rival gazumping them with a new competitor drug.
That’s why I’ve got my eye on £2bn market cap UDG Healthcare (LSE: UDG), a provider of marketing, sales and packaging services for pharmaceutical firms. The company is exposed to the upside of rising global use of pharmaceutical products, as well as the trend among pharma firms to outsource non-core operations such as training local sales teams or educating healthcare professionals on how best to use their drugs.
This is where UDG shines and as it proves its worth with existing clients and expands the array of services it offers and moves into new countries, it’s bringing in ever larger partners. This is paying off with sales for the half year to March rising 15% year-on-year (y/y) in constant currency terms to $578.9m, and pre-tax profits leaping a full 29% during the period to $52.9m.
This impressive performance has continued into Q3 with good trading and new acquisitions leading management to raise its earnings per share guidance to between 17% to 19% ahead of last year’s 31.8 US cents. The bad news is that taking the midpoint of this estimate would give UDG a valuation of around 28.9 times full year earnings.
While I see plenty of reasons to believe UDG will continue to grow organically and through acquisitions, improve its margins and maintain a healthy balance sheet, this valuation is simply too stretched compared to historic averages to make me comfortable. However, I will be keeping a close eye on the company and wait patiently for a more reasonable valuation before considering beginning a position.
Electric growth potential
Another mid-cap for which I’m awaiting a share price dip is the aptly named electronics components distributor Electrocomponents (LSE: ECM). The company serves as a middle-man between manufacturers and end users in industries ranging from utilities, to miners, electronics and manufacturers of all stripes.
The company’s growth is down to plain old macroeconomic growth across the globe as well as increasing consolidation in the sector that favours large players such as itself. Last year underlying sales grew 4.8% y/y and 17.1% in reported currency terms to £1,511m, while operating margins rose 240 basis points to 8.8% and boosted operating profit to £133m.
In the quarter to June, this growth has picked up as each of its three main trading regions, North America, Europe and Asia, grew revenue by at least 10% y/y. The combination of continued economic growth in each of these regions, small bolt-on acquisitions and increased investment in sales staff training bodes well for this growth continuing for some time to come.
Furthermore, with a highly cash generative business that produced free cash flow of £117m last year and net debt less than one times EBITDA, there’s plenty of potential for both future acquisitions and increased shareholder returns. I like Electrocomponents a lot, but its valuation of 25 times forward earnings is just a bit too expensive for my taste.
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Ian Pierce has no position in any 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.