HLMA.L - Halma plc

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Halma plc trades on the London Stock Exchange with ticker HLMA

Other tickers: HLMA.L OTCPK:HLMAF  OTCPK:HLMLY

Website: http://www.halma.com/

 

Potted description: Engineering conglomerate - multiple subsidiaries No 1 or 2 in lots of niches such as safety and asset monitoring where quality/performance trumps price. Long history of growing dividends and sound acquisitions made without over-paying. Good international exposure.

 

I think it's currently (as of January 2018) quite richly priced at 1,313 pence (GBX) = £13.13 GBP per share or $18.56 USD, giving it almost a £5bn market cap and about a 2.82% trailing earnings yield, but worth keeping an eye on in the long-run.

 

It's a high quality company with a great decentralised structure, good competitive moats in numerous niche businesses where quality and performance is far more important than price, has had consistently great ROIC and a sensible acquisition strategy and most of the time has carried little to no net debt. If purchasing again, probably in a distressed market, I'd be keen to ensure their debt is negligible before re-establishing a sizeable position.

 

I've previously held it for over 14 years (from Oct 2001 buying at a bargain price of about 134p (136p after costs), to Feb 2016 at 808p, collecting a very healthy and growing stream of dividends over that time that made for a sound Internal Rate of Return, though I squandered some of that in how I put the dividends to use, but still got over 13% CAGR on the capital appreciation alone). The total dividends over that 14.3-year ownership amounted to something like 121p per share (including about a 2-3% overall boost thanks to a UK 'dividend notional tax reclaim' that lasted until the end of 2003 in my ISA tax-free wrapper), or about 89% of my purchase price.

 

My purchase price, amid war fears after Sep 11th 2001 attacks offered a historic Free Cash Flow yield of about 8.5% and it had already amassed a 25-year+ history of growing dividends over 5% annually. My entry price recurred in early 2003 and I would have been sensible (knowing how I think now) to Value-Trade out of poorer companies selling near to IV and increase my position substantially, giving up on other shares that were only moderately undervalued at that time.

 

I only sold in Feb 2016 because Berkshire Hathaway was a screaming buy at $124 (1.23 x BVPS) and Halma was then trading at 28.8 P/E ratio (3.46% trailing earnings yield) and I'd already put my available cash into BRK.B. Since then Halma's foreign earnings have given a nice boost in depressed GBP currency and it's now on a 2.82% earnings yield (35.5 P/E), though BRK.B is still 20% ahead and I then value-traded more than my original Halma position out of BRK at $142 and into a 25% position in AAPL at $95 to even greater benefit (36% + dividends in outperformance of AAPL over BRK.B at present), helping me outperform the S&P500TR by 12.2% in 2016, so I don't feel I missed out by selling Halma at 808p.

 

I learned a lot about Halma plc on the Motley Fool UK Qualiport posts and the forums there, which are now closed, but I was recently able to find one decent post about it that was archived before their closure:

 

https://web.archive.org/web/20120519220741/http://www.fool.co.uk:80/qualiport/2000/qualiport000830.htm

 

That's a primer on Halma plc. The new boss is still doing well. Warren Buffett admired their approach and sent them a letter many years ago which they displayed on their Board Room wall. Buffett couldn't meaningfully invest due to market cap and takeover commission rules (have to make an offer if you hit 3%) but admired their disciplined acquisition approach, shareholder orientation, decentralized structure and competitive moats. I beileve Halma is still disciplined in acquiring companies to grow and is capable of a certain amount of organic growth too, where their high ROIC is very helpful.

 

A lot more was written in FoolUK Qualiport articles but it's hard to find now.

 

Annual Report and analyst presentations are useful, with focus on important fundamental metrics.

 

Halma remains on my watchlist and I'm subscribed to their investor email alerts.

 

When they make acquisitions (usually of private firms) they usually give enough information to judge at least moderately well that they're not overpaying. Often in recent years, the price they pay represents a yield on historic earnings exceeding 7% at the maximum price payable if all growth incentives are met (which presumably means significant earnings growth has then been achieved and the actual earnings yield is appreciably higher than 7%). From time to time I sanity-check their acquisition announcements and have never found cause to believe they overpaid.

 

Just today, I've found a pretty good write-up on Seeking Alpha by Stephen Simpson, CFA

 

https://seekingalpha.com/article/4139044-halmas-model-continues-drive-value-shareholders

 

I'd recommend reading that to decide if it's one to add to your watchlist of companies to consider when there's trouble in the air and prices become more attractive. It's certainly on mine and I'd gladly hold it again.

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Final Results are out for 2017-18. Another year of impressive performance, sustained dividend increase record, exceeeding £1bn revenue for the first time and entering the FTSE100 Index for the first time in Dec 2017, but the stock remains far too expensive for me to buy back in. It is actually up a fraction more than Berkshire Hathaway since I sold Halma at 838p in Feb 2016 and bought into BRK.B at $124, and I though Halma was a little pricey then, while Berkshire was very cheap.

 

The subsidiaries are fairly asset-light so the return on tangible capital employed is usually very good typically around 50%. This hasn't been reported in the main results announcements lately, but I look for it in the Annual Report and analyst presentations.

 

The company is a serial acquirer, paying substantial goodwill to buy good asset-light acquisitions, run with a high degree of autonomy at reasonable prices that should comfortably exceed their cost of capital. Return on invested capital (including historic goodwill) is well above their 12% target at a little over 15% and cost of capital is about 7.7%. This target rate seems to be reflected in their disciplined acquisition pricing.

 

Net debt is about £200-£230mn with low interest rates - about 5% of market cap and 20% of revenues and close to the annual operating profit. The debt facility is sufficient to allow opportunistic acquisitions in the next 4 years, but otherwise they would expect to keep debt at around current levels.

 

Aside from the introduction of modest debt, and some seamless changes in key personnel over the years and adjustments to the sectors they serve, divesting their old power resistors business etc., the nature of the company seems very much the same as the one I bought into in October 2001 at 136p, ~8.5% FCF yield and about 3% dividend yield. They've starting talking about their cost-of-capital in the last decade or so, but seem to have retained a sound fundamental grasp on properly allocating shareholder capital.

 

At the right price, considerably higher than my 2001 entry at 136p but considerably lower than 1400p today, I'd certainly be keen to take on a sizeable weighting in Halma plc.

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Another bolt-on acquisition of Belgian Fire Control Panel maker Limotec bvba for €9.3 million EUR (£8.2 million GBP) on a cash/debt-free basis. They only reveal last year's revenue €6.7 mn EUR so we cannot estimate earnings yield. Existing management will stay.

 

At 27th September, per their Regulatory News site, Halma's trading statement was that they were broadly in line with the Board's expectations, including constant currency growth in all sectors (US particularly strong, regionally), strong orders and a few small acquisitions and disposals. They also completed the gradual transition from the retiring Finance Director to the new CFO on 1st July. The H1 earnings release Apr-Sep is due 20th November 2018.

 

Looks like the business is still doing well, the Berkshire-like autonomous unit structure remains intact, and Halma is still compounding IV at a decent rate without taking on serious debt, but it's priced accordingly (if not more so with a trailing P/E of 31.9 at around 1300p GBX = £13.00 GBP), and I would need a much lower price to buy back in.

 

As a GARP holding I'd pay up to some extent, perhaps around 650-800p would entice me at present, and given its quality I'd be happy to take a 25-40% initial weighting in a concentrated portfolio if the value looked compelling.

 

My trading history in HLMA is roughly:

 

Oct 2001 war scare - bought HLMA at ~136p (8.4% FCF yield, about 3.5% dividend yield I think) feeling it offered much better inflation protection than cash, and a decent yield for the quality. This was fairly early in my investing career, but one of a few of my first trades at that time when I felt I understood valuation and margin of safety and was putting it into practice for the first time after early blunders.

 

In 2003 I didn't act on cheaper prices (~120p). I could have more than doubled my Halma position by trading out of my doubled-down Pizza Express position a year before that was taken private at only a little above my average purchase price. That's an error of omission. Halma had a much less price-sensitive clientele than Pizza Express, net cash, had increasing regulation as a growth driver, and a much lighter tangible asset mix and better diversity of industries and geographies and had great management making sound acquisitions too.

 

Feb 2016 sold out of HLMA at 808p (14.4 yrs, 28.8 TTM P/E). Must have collected about 80-90p in dividends per share so compounded at 13-14% Total Return IRR, though I frittered away some of those dividends in a dying local newspaper firm, while some ended up in Berkshire eventually. This was a Value Trade, using the proceeds from a fully-priced share to maximise my already enlarged position in Berkshire (BRK.B) at 1.2x projected 2015Q4 BVPS (1.234x last published BVPS) at $124-$125 USD.

 

My Halma sale price over 2017-18 earnings is now below a 20 ratio, partly from growth and partly from GBP's currency decline. The company structure is much the same, net cash is near neutral now, and the division structure and industry focus has shifted slightly, but with similar economic drivers. Dividends have continued their long history of 5%+ per year increases too.

 

If I'd just stuck with the HLMA->BRK.B trade, Berkshire's value in GBP would be about 26.8% ahead of Halma's today less about 3% for foregone dividends measured in GBP, so that Value Trade alone has mostly looked right for the past 2.5 years with only occasional periods when Halma has inched ahead by a few percent while Berkshire was cheap.

 

I actually Value Traded out of even more BRK.B shares than I'd bought with the Halma proceeds in May 2016 when an even better high conviction idea came along, but my 2 years holding Apple is another story. 2016, like 2001 was a great year for finding value buys, and good luck also played a big part, more than making up for a couple of mistakes that lagged the market.

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Another acquisition for $42.4 mn USD (£32.6 mn GBP) is Wisconsin based Business Marketers Group Inc., trading as Rath Communications, a provider of emergency communication systems for Areas of Refuge in the USA. The price paid is on a zero cash/zero debt basis.

 

Another Halma news release where it's difficult to judge the price paid, as it's 2.7x last year's revenue with no indication of profit margins. I suspect it is a relatively high margin business driven by regulatory necessity. I suspect Halma's typical approach of providing autonomy to its subsidiaries will suit this formerly privately-owned business, whose management will presumably remain in place, much along the Berkshire Hathaway model.

 

Typically in recent years they have calculated their weighted average cost of capital and ensured that earnings yields on acquisitions exceed that return.

 

At a share price of 1414 GBX Halma remains on a trailing P/E ratio of around 38, so I'm not close to buying back in.

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A short while ago Halma's Final Results at year end were released.

 

Today, there's news of an acquisition of Ampac Group, a leading fire and evacuation systems supplier in the Australian and New Zealand markets for A$135 million (£74 million), on a cash and debt free basis.

 

In the twelve months ended June 2018, Ampac's revenue and EBIT were A$57 million (£31 million) and A$13.7m (£7.5m), respectively. Ampac is headquartered in Perth with offices in Australia, New Zealand and the UK. Ampac's management team will remain with the business

 

While the information is superficial, it sounds like a very fair price for a business with good pricing power and very likely a good return on assets, and it reassures me that Halma's rational approach to acquisitions is being maintained, with management remaining in place at the acquired companies and the acquired firms retaining a lot of autonomy. They estimate their Weighted Average Cost of Capital at 7.9% and have a pre-tax earnings yield of roughly 10% on this acquisition, so they're not exactly overpaying or showing any desperation to make acquisitions to bring back their leverage to their target range. While I'm a little cautious about companies buying into the Capital Asset Pricing Model, they seem to be using it as a tool in the toolbox and handling capital allocation in quite a rational way without taking on significant debt leverage.

 

Also the Halma plc Annual Report is available from today.

 

See https://www.halma.com/investors/regulatory-news for links to all these.

 

The last year looks to have continued the very long good record on a constant currency basis (about 10% up on revenue and earnings), and even better on a GBP basis (about 13-15% up) with the modest debt being paid down a bit. Dividend up 7%, the 40th consecutive year of 5% or more dividend increase. Profit margins and return on capital measures seem to be consistently good, so great on the business Fundamentals.

 

The share price is over 2,000 pence GBX (£20.00 GBP per share) now, and although it's not a price I'd want to re-enter at (P/E around 45, versus 14 when I bought in 2001), holding onto your winners if they're good compounders over the long term can really pay off, even if they do get quite pricey and even if you have no capital gains tax to pay as a disincentive.

 

While it's only a small constituent of the FTSE-100 since joining the index in late 2017, I suspect it will continue to erratically rise up the rankings with continued compounding of its market cap at above-average rates and will gradually grow into its current valuation over the coming years.

 

It has plenty of room to grow and has highly numerous strong positions in highly defensible niche markets where low price is not the main driver for its customers, for whom Halma's products represent a tiny fraction of their costs, but often an important contribution to their safety and regulatory compliance needs.

 

Also it seems like one of the better homes for a number of private businesses looking for a cash buyer, especially those with good management in place. They do divest subsidiaries from time to time, but still tend to provide a good long term home for their acquisitions, just not to the extreme degree that Berkshire Hathaway does. And I've seen no signs of Halma over-paying for subsidiaries based on rosy projections of synergies or the like, so much of their corporate culture remains intact.

 

Perhaps it'll take something like a global recession to give me another buying opportunity, because its price is just too high for me to buy back in right now.

 

When I bought on a war scare in 2001, Halma had net cash and a slightly more conservative approach, but has changed management due to retirements and has become mildly less conservative, now uses measures like WACC that I view with a modicum of suspicion, and now has a target for modest debt leverage. As it has a wide diversity of earnings streams, I'm not too concerned about a little debt, but I'd no longer be happy to hold 75% of my concentrated GARP portfolio in Halma at any time given the remote but real chance of that debt causing permanent damage. Perhaps a price of around 700-800 pence could tempt me to take a position as large as 35% of my portfolio, depending what else is available, but for now, that's so far from current prices, I'll just monitor it from the sidelines.

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This is an interesting company, wish I ran into it earlier. Seems like much of the gains are related to multiple expansion (4-6 times multiple to fundamentals, depending what per share measure one looks at eps or CFO). Definitely not cheap, though these type of businesses tend to keep compounding for a very long time. It goes on the watchlist, and hopefully, we get a shot of less deflated entry price. Perhaps very rocky hard Brexit? One can hope, can't he? ::)

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Well, I certainly agree. I made some other investments around 2003, that I wish I'd put into increasing my Halma stake when it was even cheaper that my 136p purchase price. The GBP-denominated value of foreign earnings has been very strong since the Brexit vote, so they could get stronger if the pound remains depressed and push the valuation to even greater extremes.

 

I did consider re-investing after the Brexit vote, as I suspected the weak pound would boost GBP or GBX denominated earnings and indicate an additional nominal growth rate. I had better investments that were undervalued and very high conviction ideas, however, so I passed on paying a fairly high multiple on Halma.

 

Halma is one of the more internationally diversified firms in the FTSE100, and its business units tend to be very autonomous and independently managed (much like Berkshire Hathaway's). I suspect it could be considered a safe haven for those worried about the effects of Brexit, which might be pushing the price higher. The dividend and its long history of increases together with the record of sound acquisitions has often provided a reasonable protection on the downside, with the FCF-yield or Earnings Yield rarely exceeding 8.5-9.0% (minimum P/E ratio perhaps 11.1-11.7) where the dividend yield was probably around 3-4% or so, even during tough conditions of post 9/11 2001 or rough markets in 2003 though it's been quite a while since it was that low.

 

They were even pretty successful in the way they sold out of their old heavy-duty resistors business and refocused their business segments on what they believed were better markets characterised by growing demand and growing regulatory requirements, without the sort of huge big-bath write-downs and restructuring costs from less disciplined capital allocators. Management seems particularly long-term-shareholder oriented.

 

I think it's worth paying up a little for this quality and for very decent compounding, and I'd be more comfortable holding an outsized weighting in Halma than almost any company other than Berkshire Hathaway and holding on at relatively rich valuations too, but then again, when it gets richly valued it's tempting to Value Trade into deeply undervalued positions, which is how I got out of it in Feb 2016.

 

Perhaps I'll have to wait for worries about a widespread recession to get back into this one at a price I'm happy with, but if so, I will probably take a bigger stake than I sold and I'll go in with an expectation of holding for decades.

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There have been a few Regulatory News announcements since I last posted.

https://www.halma.com/investors/regulatory-news

 

Today they announced 2 acquisitions (PDF), one of which is reasonably large at about half of the annual net income with profit kickers.

 

Novabone has about 33% EBITDA/revenue margin or about 26% net profit margin assuming 21% tax rate and zero interest, depreciation and amortization. The purchase price net of tax benefits represents about 6.3% net earnings yield assuming $5.45 million net earnings / $88 million purchase price net of $11 million tax benefits, ignoring any earn-out payments for the next 2 years.

 

These both appear to be asset-light businesses with good margins and probably high ROE and high ROIC, in keeping with Halma's existing stable of businesses and in industries where product quality is more important than cost. So it the fits the mould of Halma's previous successes. The prices look reasonable, especially if there's room to grow.

 

Acquisition of NovaBone Products, LLC

Halma has acquired NovaBone Products, LLC ("NovaBone"), a designer and manufacturer of US FDA‐approved

synthetic bone graft products, based in Florida, USA.

NovaBone's products are used to accelerate bone regeneration, primarily for orthopaedic and dental surgical

procedures in the USA (see notes 1 and 2). It will become part of Halma's Medical sector, which includes a range of

diagnostic and surgical device companies serving niche applications in global healthcare markets. NovaBone's

management team, who were significant shareholders, will continue to lead the business from its current location.

The initial cash consideration for NovaBone is US$97 million (£74 million), on a cash and debt free basis, which will

be funded from Halma's existing facilities. When adjusted for tax benefits with a net present value of approximately

US$11 million (£8 million), the net initial consideration is approximately US$86 million (£66 million). Additional

earn‐out considerations are payable in cash, dependent on profit growth in each of the two financial years to March

2022, up to an aggregate maximum of US$40 million (£31 million), with a maximum of US$25 million (£19 million)

achievable in any single financial year.

NovaBone's revenue and Adjusted EBIT for the twelve months ended December 2019 are forecast to be US$21.0

million (£16.0 million) and US$6.9 million (£5.3 million), respectively.

 

Acquisition of FireMate Software Pty. Ltd.

Halma has acquired 70 per cent of FireMate Software Pty. Ltd. ("FireMate"), a Brisbane, Australia‐based company

which provides cloud‐based fire protection maintenance software to fire contractors.

The cash consideration for 70 per cent of FireMate is payable in two tranches. An initial A$11.8 million (£6.2 million4

)

is payable at closing and a further A$6.4 million (£3.3 million) contingent on performance to 30 June 2022, resulting

in a maximum A$18.2 million (£9.5 million), which will be funded from Halma's existing facilities. Halma also has an

option to purchase the remaining 30% of FireMate, exercisable in the six months from 31 March 2025.

FireMate's revenue and EBIT in the twelve months ended June 2019 were A$2.5 million (£1.3 million) and A$0.9

million (£0.5 million), respectively.

FireMate will be part of the Group's Infrastructure Safety sector and will continue to be led by its current

management team.

 

disclosure: I've had no position in Halma plc since Feb 2016, selling at 808p (p = GBX = 0.01 GBP) after a very successful 14.4 year hold from 136p (8.5% FCF yield) with a lot of dividends on the way. The market valuation today at over 2000p is far beyond my comfort zone (I've probably only outperformed Halma by about 5% in total since then despite beating the SP500TR by about 7.6% annualised, though I feel my downside is a little better protected), but given the quality of Halma I would probably pay up a little more than for many companies and would certainly not object to paying a fair bit over 1000p to re-enter the position, especially in my tax-free ISA or my spouse's. It would then be a core position I'd be very reluctant to sell again even if the market price seems to run away a little.

[Dynamic]

https://www.halma.com/investors/regulatory-news

 

A bit more news today is the sale of Fiberguide Industries to Molex around 12 years after its acquisition. There will be a gain declared on the purchase price. The sale price / acquisition price both on a debt-free basis amounts to around 6.3% annualised in USD terms ignoring any dividends spun off to the parent. My guess is it doesn't have the growth drivers or opportunities that Halma is looking for.

 

I can't complain about my portfolio performance since I sold HLMA 4 years ago, but it's one of those that makes me wonder about the 'never sell' approach and nearly always seems to pricey to buy. Since my purchase in Oct 2001 it has been an 18-bagger (16% annualised capital gains alone) and would have repaid my full purchase price in dividends too.