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The above table does little justice to Halma's long-term record. Since 1973, when the company's current Chairman, David Barber, became Managing Director, Halma has compounded its earnings per share at an astonishing 22.4% annual average. And ever since 1978, the group has managed a 20% annual hike in the dividend payment too.
During the five years to 31st March 2000, Halma generated £136.9m of reported pre-exceptional earnings. Subtract £51.6m of dividend payments and £5.8m of exceptional costs, and Halma has effectively retained £79.5m for subsequent use. Totalling up the acquisition expense gives us £72.8m over the same period.
Two observations from the above table stand out. Firstly, the steady nature of the traditional return on equity (ROE) calculation. And secondly, that the incremental return on equity result broadly reflects the traditional ROE calculation. Or in other words, historical assets aren't carrying those that have been recently bought. All this underpins the possibility of the recent ROE accomplishments continuing.
Why Halma? The usual reasons -- the company's financial record appears solid while its valuation isn't particularly onerous.
The business
Halma consists of six business divisions, each revolving around the design and manufacture of industrial health and safety products. The company describes each of the divisions as being "the clear market leaders in their specialist fields and, in a number of cases, the dominant world supplier."
The six divisions are:
• Fire and gas detection
• Water leak detection and UV treatment
• Elevator electronics
• Process safety
• High power electrical resistors
• Ophthalmic optics
Halma describes the key characteristics of the above business groupings as being of "predominantly electronics, based on advanced technology and offer strong potential for further growth."
The first two divisions are largely self-explanatory. Elsewhere within the group, lift door safety equipment, bursting discs (devices that prevent pressurised pipes within chemical plants from rupturing), industrial electrical resistors that absorb excess power and devices for treating eye defects are some of the other different products also designed and manufactured.
A safety dilemma
Halma, and safety equipment manufacturers in general, present one of those difficult dilemmas for investors. On the positive side, there's the "must have" factor of the products. Customers just can't risk their chemical plant being destroyed for the sake of a few relatively inexpensive bursting discs.
A world leader in certain niche safety products also allows for pricing control. Customers aren't necessarily going to balk at paying a little extra to instead turn to a cheaper, less established alternative. Increasing safety legislation around the developed world is also steadily encouraging demand for the products too.
The downside of safety equipment is that by the very nature of the product, there's little in the way of repeat business. Once you've got the fire alarms installed, you wouldn't expect the customer to return for a replacement any time soon.
Demand for lifts -- going up?
Apart from the continual search for new clients and the imposition of safety legislation, a combination of new products and certain "growth factors" are also said to inspire revenue increases.
For example, in the elevator division, Halma states that the "worldwide population drift" towards cities will increase land values that will in turn encourage taller buildings. And all that means more lifts and lift safety equipment. Indeed, a device to stop people riding on top of lifts ("elevator surfing") is also being introduced.
Having looked through the last few Halma annual reports, I'm not entirely convinced of the arguments for any major organic growth prospects. Granted there's scope for new products, but Halma's main driver of growth is through acquisitions.
The financials
Here's the five-year record of Halma. Very attractive operating margins give credence to the niche flavour of Halma's products.
Year to 31st March 1996 1997 1998 1999 2000
Turnover (£m) 173.7 200.1 213.8 217.8 233.5
Operating Profit (£m) 33.1 36.7 42.3 40.8 43.4
Pre-tax Profit* (£m) 33.6 37.1 42.4 41.8 43.8
Earnings* (£m) 22.9 25.1 29.7 28.8 30.4
Earnings per share* (p) 6.44 7.01 8.26 7.99 8.41
Dividend per share (p) 1.92 2.31 2.77 3.33 3.99
Sales growth (%) 13.0 15.2 6.8 1.9 7.2
Operating Margin (%) 19.1 18.3 19.9 18.7 18.6
EPS growth* (%) 15.2 8.9 17.8 (3.3) 5.6
(* -- pre-exceptional items)
Indeed, Mr Barber comments in the 1999 annual report that the group has always projected itself for the "longer term investor". That's good (and very unusual!) to read.
In terms of sales, it's very difficult to get a handle on the company's underlying organic growth performance. Take the year ending March 2000. Halma spent £29m on acquisitions during those twelve months, yet doesn't reveal the acquired contribution to the overall group result. Was it, as the accountants say, "immaterial"? As well as the continuing acquisition programme, the organic sales issue is also clouded by various disposals. My best guess (and it is a guess) is that average organic growth has been around 6% since 1995.
Acquisitions
Normally, I'm suspicious of companies that have ongoing acquisition strategies. It sometimes smacks of a lack of management creativity and ability. Just what happens when suitable acquisitions aren't available? In my book, there's no growth like organic growth.
However, I recognise that some companies that have low growth prospects can still, through acquisitions, re-deploy their capital at attractive rates of return. Newspaper publishers are a good example. A business that has few organic growth prospects, but can manage a superior profit reinvestment return aided by an acquisition strategy, isn't a complete investment write-off.
Acquiring growth
Halma hasn't issued any additional shares for acquisitions since 1994. Instead, corporate purchases have been funded entirely out of internally generated profit. The table below puts the cost of acquired growth in perspective to the group's pre-exceptional earnings.
Year to 31st March 1996 1997 1998 1999 2000
(£m) (£m) (£m) (£m) (£m)
Earnings* 22.9 25.1 29.7 28.8 30.4
Dividends (6.9) (8.3) (10.0) (12.0) (14.4)
Acquisition expense 4.2 22.4 0.2 17.2 28.8
(* -- pre-exceptional items)
Obviously, Halma relies on considerable corporate activity for growth. But the small amount of retained profit that doesn't get used for acquisition purposes suggests that there is little requirement for any ongoing reinvestment at Halma. This observation is borne out in the return on equity calculations.
Return on equity
Here are the relevant figures, all adjusted for goodwill.
Year to 31st March 1996 1997 1998 1999 2000
(£m) (£m) (£m) (£m) (£m)
Earnings* 22.9 25.1 29.7 28.8 30.4
Average shareholders'
equity 139.9 157.3 172.5 188.5 200.7
Return on equity (%) 16.4 15.9 17.2 15.3 15.1
Incremental return
on equity (1996-2000) (%) 14.6
(* -- pre-exceptional items)
A 15% ROE performance isn't spectacular, but it's better than average. And what's more, Halma has a pretty consistent record, a record that hasn't been aided by substantial debt either. This performance beats a company with a high-but-fast-declining ROE any day.
Valuation
"The steady, persistent and determined growth of the Halma Group is sometimes under-estimated by the casual observer" says Stephen O'Shea, Halma's Chief Executive, in the company's latest annual report.
Perhaps Mr O'Shea really wanted to say the "casual investor". With brokers anticipating 13% earnings growth this year, coupled with a current share price of 120p, Halma stands on a prospective price to earnings (P/E) ratio of 12.6. Not very expensive. (Interestingly, brokers are only forecasting a 15% dividend hike for this year. Is Halma's annual 20% dividend increase now in jeopardy?)
Halma can be summed up in a few words. Consistent, robust, unspectacular and inexpensive. Halma for the Qualiport? Certainly a company to consider further and a company that wouldn't look out of place in the portfolio.
But from this brief review, and if you ignore Misys (LSE: MSY), which is on the chopping block anyway, not a company that instantly appears head and shoulders above the portfolio's six other members.
Dump Buffett?
Over the past few months, I've been thinking (but not writing) about the general direction of the Qualiport and its philosophy. In short, maybe it's time to consider alternatives to Buffett and his stock picking ways. His may be the purest form of investing, taking a business owner's perspective, but a successful implementation of the strategy is, to say the least, difficult. Essentially, we're encompassing somebody else's methodology with our own stock picking ability. On the face of it, not an obvious recipe for prosperity.
Instead, should our attentions be turned to the thoughts of Buffett's mentor, Ben Graham, a man famous for the "statistical bargain" stock? That's right. The introduction of shorter term Qualiport "value plays" will be entertained on Friday. Let us know what you think on the Qualiport discussion board, in the Resources section below.
Where Next?
• Visit TMFJimmyC on the Halma discussion board and review Happy Harry.
• And then visit the Qualiport archives to learn about adjusting for goodwill and incremental return on equity.