QUALIPORT
Review: Health and Safety Companies

By Maynard Paton (TMFMayn)
June 25, 2001

Carburton Street, London -- After formally reviving the Qualiport's watch list the other week, it's worth presenting the occasional feature highlighting the performances of those companies this portfolio has an eye on. With that in mind, today's article will briefly review the full-year results of Halma (LSE: HLMA), SSL International (LSE: SSL) and Latchways (LSE: LTC). The three companies, which coincidentally are all involved in health and safety matters, all published their numbers in recent weeks.

Halma

Halma delivered its annual results last week. The safety and environmental technology group reported profits slightly ahead of expectations.  

(year to 31 March)             2001          2000    Change (%)

Turnover (£m)                 268.3         233.5     +15.0
Operating profit (£m)          49.7          43.4     +14.5
Pre-tax profit (£m)            49.7          43.8     +13.5
Earnings per share (p)          9.5           8.4     +13.0
Dividend per share (p)          4.6           4.0     +15.0

My views on this performance can be found here. Overall, the fundamental attractions to Halma remain firmly intact. The following paragraph, taken from the company's latest statement, sums up the investment merits:

"The Group creates and markets unique products that save lives and protect health... Our long-term record of high levels of free cash flow and high levels of return on investment provides us with opportunities to produce strong organic growth based on investment in unique intellectual assets. The stability and self-reliance of our company... enables us to build and sustain high market shares in growing market sectors, many of which are relatively insensitive to consumer demand."

The only quandary with Halma is valuation. At 159.5p per share, the company stands on a historic free cash flow yield of 5.8%. (It's worth noting that medium-dated Government bonds presently yield a risk-free 5.4%.)

Given the bullish noises made by the Halma management last week, it's worth factoring in some short-term growth in any valuation calculation. Assuming free cash expands at 8% (the organic growth rate just reported) Halma shares offer a prospective free cash flow yield of 6.3%. All in all, I'd be tempted with Halma at around 130p and a prospective free cash flow yield of about 7.7%.

SSL International

SSL presented its final results three weeks ago. They were not a pretty affair. To recap, SSL was essentially formed through the three-way merger of health product groups Seton Healthcare, Scholl and London International. Subsequent logistical issues led to one or two profit warnings, which led to fresh management, which in turn led to an investigation into the previous management's accounting policies.

To say the least, SSL is a "glitch" investment.

Unsurprisingly, SSL's results were littered with exceptional items. The following table highlights the (so-called) "underlying" picture.

(year to 31 March)             2001          2000    Change (%)

Turnover (£m)                 268.3         233.5     +14.9
Operating profit (£m)         116.0         130.5     -11.1
Pre-tax profit (£m)            91.3         111.3     -18.0
Earnings per share (p)         38.9          45.6     -14.7
Dividend per share (p)         12.3          12.0      +2.5

For what it's worth, SSL reported underlying growth of 7%. However, although SSL's finances are a mess, their premium healthcare products remain very investor-friendly. All are market leaders, in areas where price is not the primary consideration for the consumer, and where repeat and recession-proof purchases are prevalent.

Given the uncertainties and the prospect of further exceptional charges in the pipeline, it pays to incorporate a significant margin of safety when considering an SSL investment. At 526.5p, SSL shares offer a historic, and pre-exceptional, free cash flow yield of 5.1%.  At the moment, receiving an 8% pre-exceptional free cash flow yield would be the absolute minimum I'd demand from SSL. That requirement equates to an entry price of 338p.

At the moment, the stock market has clearly priced in a full recovery into the shares of SSL. In my view, the recovery is far from complete.

Latchways

Latchways revealed a rather flat full-year performance in late May.

(year to 31 March)             2001          2000    Change (%)

Turnover (£m)                   9.4           8.7      +8.0
Operating profit (£m)           3.0           2.8      +7.1
Pre-tax profit (£m)             2.9           2.8      +3.6
Earnings per share (p)         18.6          18.9      -1.6
Dividend per share (p)          6.1           5.5     +10.0

Sales of the company's fall arrest equipment increased by 6% in the UK and by 65% in the US. However a 29% plunge in European revenues caused the static performance. Continental difficulties were caused by the weak Euro and sales delays occuring with new clients.

Nevertheless, the company is still the market leader in its niche safety industry. While competition in its market place is increasing, Latchways' greater resources, allowing the formation of relationships with the emerging blue-chip "volume" customers, are creating a further competitive advantage.

The growing importance of relatively few, larger volume clientele to Latchways will make its future profits increasingly volatile. While profits at Latchways could have substantially improved by, say, 2006 (going on the "considerable opportunities" and "significant potential" for its safety equipment), any profit growth will not be generated in the linear fashion the stock market so often desires. Hopefully, this "lumpy" growth should lead to investment opportunities as and when the stock market decides to focus on the inevitable short-term profit setbacks.

At 312.5p, Latchways shares offer a historic free cash flow yield of 5.8%. With current year profits expected to remain static, should the shares ever fall below 240p, to offer a 7.5%-plus free cash flow yield, I'd be a buyer.

More: Revisit the initial Qualiport proposals for Halma, SSL International and Latchways.

The author holds shares in Latchways.