Monday, 16 June 2014

Halma finals

Halma p.l.c

Designs, manufactures & markets equipment for process safety, infrastructure safety, medical and environmental & analysis.  Typical products include - fire detectors, gas detectors, water treatment systems, ophthalmic instruments and machine safety systems.  I have a holding in my income portfolio (epic code: HLMA).

Halma announced their final results on Thursday last week with profit before tax (PBT) just short of the previous market consensus, see here for comment.
Growth in continuing operations saw revenue up 9% to £676.5m and adjusted PBT up 9% to £140.2m.  Organic revenue growth at constant currency was up 6% and PBT up 5%.  Diluted EPS was up 13.6% to 28.13p and the final dividend was increased by 7.1% to 6.82p, producing 11.17p for the full year an increase of 7.1% and making this the 35th consecutive year of dividend increases above 5%.  The dividend is covered 2.52x by earnings and 2.14x by free cash flow (FCF).
FCF was again strong at £90.2m compared to £85.9m in the previous year.  After dividend (£40.5m) & acquisition (£16.7m) payments out of FCF, net debt was reduced by £35.8m to £74.5m.  This net debt represented just 15.3% gearing and the ratios of debt/EBITDA and OCF/Debt were equally strong at 0.4 and 160% respectively.

Halma performs well on most metrics with a ROE of 22.6% and a ROCE of 25.6% compared to a WACC of 9.8%.  Over the last 5 years they have returned dividends and grown their book value per share (equity) by a compound 17.3% pa, backed up by FCF per share generation of 18.8% compound pa on the opening book value per share.

Halma does have a defined benefit pension scheme, but this has been closed to new membership since 2003 and by December of this year will be closed to future accrual.  The scheme currently has a deficit of £36.8m so perfectly manageable and the company is currently paying £7m pa to clear the deficit.

The company achieved revenue growth in all territories, with China (obviously part of Asia Pacific) growing by 26% and now representing almost 7% of the Group.  Management are targeting revenue from outside of UK, USA and Continental Europe to be 30% by 2015, as can be seen below it is currently at 25%:

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There was revenue and profit growth in all four sectors, with Medical performing the strongest with a considerable contribution from acquisitions made in the prior year:

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*Profit is shown as: before amortisation of acquired intangibles, acquisition items, curtailment gain on DB pension schemes and profit or loss on disposal of operations.
Management in their outlook statement stated that "...Our proven ability to achieve organic growth and regularly complete good quality acquisitions gives us confidence that Halma will make further progress in the year ahead..."  The year just ended was quiet on the acquisition front, with just one completed.  I would expect this pick up again if they can find the right targets at the right price, indeed three acquisitions have been completed this financial year already and they state that the pipeline of potential candidates is good.

I have held Halma in my income portfolio since May 2007, but sold 87% of my holding in January 2011 as their valuation became stretched and the yield declined substantially, so they now represent just 2.5% of the portfolio.  Over the seven years I have held them they have returned just over 15% compound pa. with the dividends not reinvested.  With first class management running this company, I would expect a similar return over the next seven years.

The quality of the company is first class, but unfortunately for any new investment this is reflected in the valuation of the company, with an historic P/E of 21.3 and a prospective 20 for this current year and a below market yield of 1.9%. 

On a discounted cash flow valuation I would place a fair value of about 530-610p (current price 600.5p) assuming FCF growth of 10-12% pa for 10 years, 3% in perpetuity and a discount rate of 10.7% (estimate of their cost of equity).  Halma would have to grow their FCF by 15% pa for those first 10 years for today's price to be considered good value (this would produce an intrinsic value of 760p), this might be possible as their five year and ten year historic growth has been around 14% pa.

For me though the margin of safety on a conservative forecast, is insufficient for me to build my holding back up and the dividend return too small.  A quality business, but while acquisitions have such a major call on their FCF, I can't see the pay-out ratio of FCF deviating much from their current 3 year average of 47%, so the yield is likely to remain sub-median.

Saturday, 7 June 2014

Dillistone Group growth portfolio candidate

Dillistone Group Plc is a leading global provider of software and services to recruitment firms and recruiting teams within major corporations. I have no holding in the company (epic code: DSG).

AIM/AIM All Share
Software & IT Services
Market Cap
Share Price
Norm. EPS
Historic P/E
Est. 2014 growth
Prospective P/E
Est. 2015 growth
Prospective P/E
Rolling PEG
Historic Yield
Operating Margin
5 yr BV + Div return
5 yr FCF return on BV

The business is split into two divisions, Dillistone Systems (61% of Group sales) and Voyager Software (39%). Dillistone Systems specialises in the supply of software and services into executive-level recruitment teams. Voyager Software’s clientele are primarily involved in contingent recruitment, including permanent placement, contract placement and the provision of temporary staff.

The majority of their products are delivered through one or more of the following:

1. an upfront licence fee plus a recurring support fee;

2. software as a Service subscription basis, or

3. a hybrid model incorporating an upfront payment and recurring support and hosting fees.

Recurring revenues represented 65% of their £8.1m sales for the year ended 31st October 2013.  Total revenue grew 14.9% last year, while recurring revenues grew 16.4%.  Management have stated that they are seeing a trend towards purchase of their software and services on a subscription basis (2 above), which may deplete income in the near term, but higher income over the long term.

The company has offices in four countries, the UK, Germany, the US and Australia, employing 100 people.  Income for the UK operation represents 76% of total sales, USA 15% and Australia 9%, although they do sell into about 60 countries from these operations.

The market for recruitment software is extremely fragmented, with a large number of small suppliers operating in all of the Group’s geographical territories.  This creates a highly competitive market, but despite that DSG are able to achieve high levels of return (as shown in the table above), in addition their return on capital employed is a very substantial 48.3%.  A consolidator in this niche market would find it difficult not to be attracted by DSG’s profile.

Although DSG’s 5 year EPS growth has been just 3.5%, recent performance shows substantial improvement with a three year CAGR in EPS of 10.7% and this year expectations are for 21.4% and next year 11.9% growth.  At a share price of 105.5p the company has a rolling one year P/E of 11.9 and rolling one year growth of 16.8%, producing an attractive PEG of 0.7.

With such a high level of operating margin and little or no working capital requirements due to substantial deferred income relating to payments from customers for future services and support, free cash flow (FCF) is very strong.  Free cash flow last year was £1,285k up £502k from the previous year and at 6.8p per share DSG has a FCF yield of 6.4% on a share price of 105.5p, compared to a stock market median of 5%.

Based on an expected dividend of 4.2p this year, DSG is offering an attractive 4% yield and the board states that they are committed to a progressive dividend policy.  Last year’s dividend was covered 1.7x and this year’s dividend is expected to be covered a comfortable 2x.

The directors have a high stake in the business owning 43.4%, with their ex-executive chairman (resigned February 2010) still owning 14%.  Other major investors are Herald Investment Management with 9.7% and Unicorn Asset Management with 4.9%.  

On a discounted cash flow basis I would place a value of around 134p on the shares.  This is based on last year’s FCF of £1.29m growing at 12% pa. for the next 10 years and then 3% in perpetuity.  I have used a discount rate of 13% based on their cost of equity of 10% and applying a 30% premium for a micro-cap.  This provides an attractive margin of safety of 27% for a potential investment.

In summary, Dillistone is a very small company operating in a fragmented niche market with a customer base that is cyclical by nature.  The company does though have very good historical returns, a strong free cash flow and a management committed to deliver solid investment returns through their substantial shareholding in the business.  The cyclical nature of the customer base is offset by the high proportion of recurring revenue and the geographical spread of DSG's sales.
Dillistone is covered by just their house broker W H Ireland and the shares are fairly illiquid with small volumes being traded.  Their interim results are likely to be announced in late September and management do say that though they expect sales to be up on last year, profits are likely to be down slightly due to strengthening of their management team and increased amortisation costs for R&D, but they expect to see profitable growth for the year.   

Thursday, 5 June 2014

API Group finals

API Logo

API Group PLC a global supplier of foils, films and laminates.  I have a holding in my growth portfolio (epic code: API).

API Group announced their full year results yesterday and stated that group revenues for the twelve months to March 2014 increased by 2.0% to £114.7m.  Sales volumes were higher by 2.7%, with second half volumes up 7.1% on the prior year, compensating for a small decline in the first six months.
In spite of these higher sales levels, management said that added value margin declined slightly due to the sales mix between the business units, the impact of less favourable exchange rates and higher levels of production scrap at Laminates.  This, together with slightly higher variable costs, more than offset the contribution from higher sales, to leave pre-exceptional operating profits down by 4.8% at £7.4m.
Diluted EPS was down 1.4% to 7.1p, if we exclude exceptional items the EPS was 7.8p down 7.1%.  The directors are proposing a final dividend of 1.3p per share, making 2.0p for the full year; the first dividend paying year since 2001.
Free cash flow at £3.97m was up £2.26m on last year and represented 5.1p per share.  Consequently the net debt position of £3.2m last year was turned in to a net cash position of just over £0.1m.
API is an interesting company:
  • with opportunity for growth - see here for my initial write up;  
  • at 72p a reasonable price - 9.2x historic earnings, 7.8x the consensus estimate for this year and 2.1x book value, for a company that is expected to grow earnings by ~18% this year; 
  • a strong balance sheet - net cash and undervalued tangible assets in the form of property*.
  • a strong activist shareholder base Steel Partners (32.4% holding), Wynnefield (29.7%) and Crystal Amber (11%).
It is worth noting though that the company does have a substantial net liability on their defined benefit pension funds of £13.4m, although they are closed to future accruals.  The company has agreed with the trustees to pay £700k pa until 2019.

*Their 20 acre Rahway New Jersey site could be worth up to $18m based on similar property in the area.

Synergy Health finals


Delivers a range of specialist outsourced services to healthcare providers and other clients concerned with health management. Such as hospital sterilisation services; applied sterilisation technologies for single-use medical devices; reusable surgical solutions for daily delivery of sterile reusable gowns and towels; clinical pathology, toxicology and microbiological services; chemical and microbiological analysis; linen management services for healthcare facilities and product solutions designed for infection prevention and control, patient hygiene, surgical procedures and wound care.  I have a holding in my growth portfolio (epic code: SYR)

Synergy announced their final results yesterday with revenue of £380.5m up 5.3%, and after removing the impact of currency movements was up 4.1%.
Gross margins were up 190bps to 40.9% and adjusted EPS up 7.6% to 70.59p, with diluted EPS at 57.05p an increase of 9.8%.  Management are Proposing a final dividend of 14.20p, which together with the interim dividend would give dividends for the year totaling 22.77p representing an increase of 10.0%.
In 2013/2014, they state that the company won a number of contracts that in aggregate added £0.5bn to their forward order book, which now stands at £1.5bn, giving the company substantial visibility going forward.
Free cash flow was again strong at £39.4m compared to £34.4m last year, with net debt being reduced by £29.7m to £147.6m, representing gearing of 43% and covered 54% by their operating cash flow. 
Management expect that their new contracts wins of £43 million per annum will be implemented over the next sixteen months and this will raise their growth rate, although due to investments in R&D they expect to see their operating margins reduce by 50bps.  They do though expect their growing bid books and bid conversions, that will ultimately drive top-line growth, to off-set this investment in R&D. 
I have held SYR for 9 years now and they have been a good growth stock, with their share price over that time growing by over 14% compound per annum.  Today at 1311p they look fully priced at 16.8x this year's forecast EPS of 77.9p.  Those forecasts are for 10.4% growth for this year and just 5.8% to 82.4p in 2016.  There may be better prospects elsewhere, so I may part company with my longest held growth stock.  

Tesco 1st qtr IMS

One of the world’s largest retailers.  I have a holding in my income portfolio (epic code: TSCO)

Tesco released their first quarter IMS yesterday and there is not much more to be said in addition to what already has been commented on in the press.  Trading continues to be poor and there are questions over whether Philip Clarke is the right Chief Executive at this time for Tesco.

I continue to hold the shares (despite it being the worse performer in my portfolio) for the 5% yield and the belief that Clarke with his substantial retail knowledge is probably the best person to lead the company back to growth, but he needs to prove that he can act faster than he did over their US Fresh & Easy chain.

The first quarter showed UK like-for-like sales including VAT (exc. petrol) down by -3.7%.  International sales increased by 0.5% at constant exchange rates, although with a significant currency impact sales declined by -8.0% at actual rates.  Group sales declined by -0.9% (at constant rates, exc. petrol).

Continuing to be patient for now. 

Sunday, 1 June 2014

Paypoint finals

Provides clients with specialist consumer payment transaction processing and settlement across a wide variety of markets: (energy pre and post-payment, telecoms, housing, water, transport, e-commerce, parking and gaming) through its retail networks, internet and mobile phone channels. I have a holding in my income portfolio (epic code: PAY).

Paypoint announced their final results on Thursday.  Revenue was up 1.7% to £212.2m and profit before tax up 11.5% to £46.0m. Diluted EPS was up 16.1% to 52.6p and the final dividend increased by a substantial 18.3% to 23.9p, making 35.3p for the full year which was up 16.1% and is covered 1.5x.  This follows on from last year when a 15p special dividend was declared, adding to the total  normal dividend of 30.4p in that year.
Total transactions increased by 3.9% to 767.5m, with mobile and online transactions up strongly by 15.9% to 132.2m. 
Their Collect+ joint venture is now profitable and added £892k to profits in the year.  Collect+ Parcel transactions rose 76.4% to 13.6 million and revenue was up 92%.
Free cash flow was again strong at £34.3m up 12.5% on last year and net cash ended up at £41.6m (including £6.5m of client cash) after a £10.2m payment for the special dividend, compared to £46.6m (including £7.0m of client cash) last year. 
Management state that for the current financial year, trading is in line with their expectations.  Although at 1055p Paypoint looks to be fully valued at 20x 2014 earnings and 17x expected 2016 earnings, it does come with an excellent dividend paying pedigree, returning 152.4p to shareholders over the last 5 years, growing the normal dividend at almost 15% pa. and still comes with a prospective yield of 3.5%.