Investing in product development
Animalcare Group Plc (ANCR.LSE) is increasing its investment in new product development as it uses its balance sheet and operational cash flow to improve its product portfolios. The strategy of exiting low-margin and commoditising segments and investing in defensible, higher value-adding products is wise, although the benefits are not expected to accrue until after 2017. The current valuation has yet to capture the potential of this approach.
New product development is key for future prosperity
The animal health market shares many characteristics with its human counterpart but the success factors are subtly different, with financial muscle and global reach being less critical. Nonetheless, the competitive pressures are rising and the importance of having a portfolio of differentiated and value-adding products is growing. Animalcare is pursuing a strategy of de-emphasising the low-margin (and commoditising) segments and investing in new product development.
H114 results highlight strength of current operations
H114 results showed revenues up 5.9% from £6.1m to £6.5m, driven by a 10.7% increase in Licensed Veterinary Medicines sales (up from £3.6m to £4.0m) and a 5.6% rise in Companion Animal Identification (from £1.1m to £1.2m) which more than offset the 6.5% decline in Animal Welfare (from £1.4m to £1.3m). Underlying operating profit dipped by 2.9% from £1.5m to £1.4m, with underlying EPS down by 5.2% from 5.8p to 5.5p. The interim dividend was maintained at 1.5p.
Internal resources are sufficient to fund pipeline
Despite the rise in working capital, mainly in inventories to safeguard key product lines, Animalcare remains nicely cash generative, with an operating cash flow of £0.9m (H113: £1.3m) and the net cash increased from £3.0m to £3.6m. The strong balance sheet and operational cash flow should allow management to fund the increased investment in the development pipeline organically.
Valuation: Future growth potential yet to be priced in
The greater investment in R&D in the near-term means Animalcare’s earnings multiples fail to reflect the value expected to be generated. Our previous valuation of £40.0m was based on an average of DCF and peer-group earnings multiples; however we have expanded our DCF model and are using the peer multiples as a reality check. The DCF valuation is results in a valuation of £41.5m (up 4%).
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