Supplying veterinary medicines, animal identification and other products to the ‘companion animal’ veterinary and livestock markets, Animalcare Group offers growth and a defensive bent in uncertain economic climes, writes James Crux

Formerly PLUS-traded as the rather unexciting Ritchey, the growth, cash-generation and profit prospects of the group were totally transformed through the £13.4 million cash and bank debt funded acquisition of Animalcare from Genus Plc last January.

The takeover was financed with the help of a £6.4 million placing with institutions, and accompanied by a name change and move to AIM, extending the group’s focus from the staid livestock sector into the exciting, high-margin and growing companion animal market (companion animals are defined as horses or small animals such as dogs and cats). Animalcare has delivered on all its pre-deal promises and offers investors exposure to growth through a new veterinary medicines programme, which is gathering momentum.

What’s more, shares in this cash-generative, dividend-paying counter are selling for less than ten times earnings.

Strategy
Guided by ambitious CEO Simon Riddell, Animalcare is focusing efforts on niche areas of the burgeoning companion animal market and the more stable livestock sector. As well as increasing sales through the existing customer base and distribution network, Riddell has a stated strategy involving further broadening of the product range, entering new markets and making further select acquisitions.

Following January’s merger, there are now two divisions within the group. The profitable Animalcare is focused on the companion animal market via its established links with veterinary practices. As well as marketing and selling a range of licensed veterinary pharmaceuticals, animal-identification microchips and other vet supplies to UK and Ireland wholesalers, for onward distribution to vets, the business supplies wares to charities such as the RSPCA.

Of most interest to analysts and investors is the division’s pipeline of new and high-margin pharmaceutical products for companion animals, an activity benefiting from EU drives to promote the development and use of veterinary pharmaceuticals.

Ritchey, meanwhile, is a well-regarded brand in the agricultural market, whose core products include agricultural supplies and livestock identification ear tags for cattle and sheep (necessary for compliance with EU requirements). Boasting around 1,000 customers – many of them regarded as ‘key’ accounts – Ritchey also supplies equine, vet, pet and hygiene products and is looked upon as a ‘cash cow’ by analysts.

As Riddell explains: ‘Ritchey has the ability to generate significant top-line revenue, but margins aren’t great. It is a cash-generative business with modest growth potential – livestock numbers have reduced and the long-term view, while not adverse, is not as favourable as that of the companion animal market’. Within the latter sector, the development and introduction of generic licensed veterinary medicines offers exciting growth for the group and its investors.

Management
The enthusiastic Riddell occupies the chief executive’s hot seat. Before joining Ritchey, Riddell, who spent ten years with consumer products behemoth Procter & Gamble, enjoyed a five-year stint with Mayborn Group running the group’s Sangenic nappy business.

Entrepreneur James Lambert is non-executive chairman. He built up Richmond Foods through acquisitions into the largest ice cream maker (by volume) in the UK. Richmond exited the stock market in April 2006 after its £176 million sale to US private equity group Oaktree and subsequent merger with European ice cream-making giant Roncadin, which Lambert now runs.

Other key board members include FD John Tobin and Stephen Wildridge, MD of the Animalcare arm. He is charged with formulating Animalcare’s new product development strategy and, significantly, also sits on the board of NOAH, the National Office for Animal Health.

Prospects
Financials for the year to June showed a dramatic 40 per cent surge in sales to £11.76 million and a doubling of ‘adjusted’ pre-tax profits to £1.21 million, although this reflected almost £4 million of revenues from the acquired Animalcare business. Animalcare’s annual sales grew by a very respectable 6.3 per cent year on year, to £8.1 million.

From earnings of 8.3p (2007: 9.4p), the dividend was maintained at a better-than-expected 2.25p, reflecting management’s confidence in the business following a year of ‘excellent’ cash flow.

Over at Ritchey, revenues reversed from £8.3 million to £7.8 million, partly due to outbreaks of foot and mouth and bluetongue, which led to reduced livestock trading and lower livestock tag sales. Encouragingly, there has lately been a marked improvement in agricultural market-trading conditions and, given Ritchey’s broad product range and links with agricultural retailers and farmers, it has the potential to deliver ‘satisfactory profitability’ in the future.

Far more exciting is Animalcare, continuing to develop and introduce generic licensed veterinary medicines and, importantly, whose product pipeline is beginning to deliver.
First up is Benazecare, a generic version of a canine heart-failure treatment. It has received marketing authorisations in key EU markets and made its first product shipments to distribution partners in EU countries.

He is also upbeat about Buprecare, a morphine-derived analgesic for pre- and post-operative pain in companion animals that was launched in September. ‘Incumbent’ product Vetergesic (owned by Reckitt Benckiser) already generates sales in the UK of £2.2 million, and as well as the potential for near-term growth in the UK – first shipments have already been made to vets in the UK and Ireland – Animalcare has first-mover advantage in Europe, since no equivalent product is available in the EU.

The third key project, shrouded in a degree of secrecy for commercial reasons, is ‘Project Gouda’, an antibiotic being co-developed with a Dutch partner, already sold in Holland and being primed for release in the UK and other European territories. ‘We have a marketing authorisation and we’ll start shipping in Q3 of 2009,’ asserts Riddell.

‘We are pleased with our new product development programme. Benazecare and Buprecare are on stream and performing well, and we have a number of other products in the pipeline over the next one to three years.’

With investors rightly worried about the effects of recession on corporate earnings, it is worth noting that the company’s growth prospects are strongly underpinned by the resolute nature of spending within the market. Roughly 70 per cent of the group’s earnings are now derived from this defensive sector, which should enable Animalcare to withstand any short-term pressure on pet owners’ disposable income as the economy slows.

Valuation
Shares in Animalcare, which have fared better than most smaller companies since its move to AIM at the start of 2008, currently trade on an undemanding rating and at an attractive entry point for investors, who may have noticed recent director buying at 53p and 60p following recent results.

For the next two years, house broker Brewin Dolphin foresees healthy organic growth. For June 2009, pre-tax profit is forecast to rise to £2 million, on turnover of £17.6 million, ahead of £2.6 million from £19 million sales the following year. And while this year’s earnings are set to reduce to 6.9p (on a higher tax rate), earnings growth should resume in 2010 to 8.8p per share.

Based on those metrics, the shares are trading on 9.8 times this year’s earnings and just 7.7 times next, which indicates good value. Those ratios look decidedly ungenerous considering growth prospects, cash flow characteristics and expected dividends of 2.5p and 2.8p for this year and next, offering investors yields of 3.6 and 4.1 per cent.

Also significant is Brewin Dolphin’s sum-of-the-parts valuation and 12-month price target of 82p. This suggests that significant upside in the share price, should smaller company sentiment improve, is highly plausible.