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QUALIPORT
By
Investors often suffer from acquisition mistakes. But those following Halma (LSE: HLMA) have a different story to tell. The Qualiport company has a long, successful record of corporate activity and two canny purchases in the recent months re-emphasise the management's common sense approach to takeovers. Both acquisitions meet the golden rule of long-term investing: buying a good company at a cheap price. The two are leading players in their respective markets, with Diba Industries specialising in 'health and diagnostic components' and Ocean Optics focusing on 'optical sensing and electro-optics systems'. Halma is of course chock-full with similar market leading subsidiaries, which produce a wide range of health and safety products such as fire alarms, water analysers, lift sensors, bursting discs and electrical resistors. The attractions to Halma -- and no doubt its new additions -- revolve around intellectual property and reputable brands (which help form good barriers to entry), price-insensitive customers (because product failure is often very high relative to cost) and worldwide legislative pressure. More on Halma's buy and hold attractions can be found here and here. The financial details relating to the acquisitions are shown below:
Diba
Ocean
Optics
Price (£m)
7.9
13.6
Sales (£m)
6.7
13.7
Profits (£m)
1.0
2.5
Net assets (£m)
2.5
3.3
Price to sales
1.2
1.0
Price to 'earnings'
7.9
5.4
Profit margin (%)
15
18
Return on net assets (%)
40
76
Some clarification is needed with this table. Firstly, the profit figure for Ocean Optics was before tax, while it's unclear whether Diba's reported profits were before tax or after. In addition, the stated figures may have been affected by undisclosed one-off items.
That said, it is clear Halma got two very good deals, with the takeout profit multiples in both cases in single digits. (For Ocean Optics, additional payments of up to £13.6m will be paid if the subsidiary's profits more than double by March 2006.) Not only that, but the implied profit margins and return on net asset figures suggest two operationally strong companies. Importantly, these were not some minor bolt-on purchases for Halma. The aggregate cost was £22m; group full-year earnings revealed today came to £35m.
Those full-year results extended Halma's solid financial progress:
| Year to March 31 | 2000 | 2001 | 2002 | 2003 | 2004 |
|---|---|---|---|---|---|
| Turnover (£m) | 233.5 | 268.3 | 267.6 | 267.3 | 292.6 |
| Operating profit* (£m) | 43.4 | 49.7 | 48.0 | 46.1 | 50.0 |
| Exceptional items (£m) | (7.8) | - | - | - | (9.1) |
| Pre-tax profit* (£m) | 43.8 | 49.7 | 48.3 | 46.5 | 41.1 |
| Earnings per share* (p) | 8.4 | 9.3 | 9.1 | 8.6 | 9.4 |
| Dividend per share (p) | 4.0 | 4.6 | 5.3 | 5.8 | 6.2 |
(*adjusted for goodwill)
Despite 'difficult' market conditions, the year to March 2004 saw sales and profits move forward for the first time in three years. Turnover and operating profits improved 9% to £293m and £50m respectively, with the £46m purchase of BEA (the world leader in automatic door sensors) providing its first full-year contribution.
Excluding BEA, progress would have been only 3% better. Though underlying growth was pedestrian, operating margins remained strong at some 17%, or 18% if adjusted for some small disposals.
Cash flow and balance sheet
Halma's cash flow was impressive during 2003/04:
| Year to March 31 | 2000 | 2001 | 2002 | 2003 | 2004 |
|---|---|---|---|---|---|
| Operating profit* (£m) | 43.4 | 49.7 | 48.0 | 46.1 | 50.0 |
| Change in working capital (£m) | (1.8) | (1.3) | 0.5 | 8.8 | 0.5 |
| Depreciation (£m) | 6.3 | 7.0 | 7.4 | 7.6 | 7.9 |
| Net capital expenditure (£m) | (7.2) | (8.3) | (6.5) | (9.4) | (8.7) |
(*adjusted for goodwill)
No problems with working capital once again, as Halma generated an inflow for the third year running. In addition, spending on tangible assets was minimal when set against the depreciation charge.Halma noted this year's gross capital expenditure was 'again at a typical level of around 125% of depreciation', although the past five years has witnessed net capital expenditure equivalent to 111%. Whichever way you juggle the figures, it's fairly easy to see Halma isn't bogged down with major tangible assets, but instead benefits from inherently difficult-to-replicate intangible items.
The solid cash flow performance transformed a tiny net debt position into net cash of £22m (roughly 6p per share). It also allowed the full-year dividend to be lifted 7% to 6.2p per share.
Though light on assets, Halma's recent return on equity performance has not been spectacular. In the five years to March 2004, underlying earnings have increased by £5.7m to £34.6m. Over the same time, Halma's equity base (adjusted for goodwill) jumped £74.5m to £270.5m. The resulting incremental return on equity therefore comes to an unremarkable 8.2%.
Causing the lacklustre returns has been Halma's tough markets (sales were flat during 2001-2003) and acquisitions (notably BEA), whose contributions have only now started to make a meaningful impact on the calculations. When Halma's markets turn -- as they surely will at some point -- shareholders can expect the new subsidiaries and a large R&D budget to support further progress. For the record, the group reported incremental returns of 13%-plus during the buoyant 1990s.
Halma also made a passing reference to its pension shortfall, stating it had reduced by 7% to £29m after related deferred tax. With annual earnings of £35m, this is one of the relatively larger deficits on the portfolio's watch list.
Valuation and summary
The recent acquisitions and today's results show no sign of any deterioration in Halma's quality. Sure and steady is the name of the game here, as the company continues to develop/acquire market-leading products and produce decent accounts.
Sadly, today's 160p share price does not offer great value. Based on these results, the price to earnings ratio is 16.9 and the dividend yield is 3.9%. Furthermore, Halma produced free cash of 9.3p per share in the twelve months under review. Account for the cash pile, and a 129p buy price is required for a historic 7.5% free cash flow yield.
Finally, as well as the sensible acquisition strategy, another boardroom highlight is the incoming chairman. Judging by his maiden annual statement, Geoff Unwin has been quick to help the group step up a gear.
After noting the company's performance, as measured by its historic high standards, had 'not moved ahead as we would have wished', Unwin has prompted some 'lively' management debates, whereby 'no factor remained unexamined, no cow, sacred or otherwise, undisturbed'. Various actions have taken place, which hopefully should make this great company even greater.
Trading update
Within the next five trading days, the Qualiport will sell its entire Carpetright (LSE: CPR) holding and reinvest the proceeds and its current cash balance into Associated British Ports (LSE: ABP).
Maynard writes every month for the Motley Fool's Value Investor newsletter. He also owns shares in Halma and Carpetright.