Back in the 1990s, Diploma (LSE: DPLM) realised its core businesses distributing electronic components, building products and special steels had matured into cyclical, lower-margin endeavours in sectors that were in structural decline.
Some firms would have just accepted the situation, but to its credit, the management team decided to take bold action instead. The directors fired up a new acquisition programme aimed at diversifying into more attractive sectors, and the company sold 10 of its existing businesses over three years. At the beginning of this century, it had a war chest of cash from the sales to fund future acquisitions and growth initiatives.
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The transformation of the firm’s activities saw it move from being a mainly UK-focused operation to an international one. Now, around 25% of revenue comes from the UK and the rest from North America and mainland Europe, earned from distributing technical products to the Life Sciences, Seals and Controls industries. These include consumables, instrumentation, environmental analysers, containment enclosures and emissions monitoring systems.
The firm aims to make itself an indispensable link in its customers’ supply chains by focusing on supplying “essential products and services,” which customer-organisations buy from their operating, rather than their capital, budgets. Diploma reckons the tactic provides recurring income and stable revenue growth, and it’s hard to argue with the firm’s record of trading. Over the past six years, the compound annual growth rate (CAGR) for revenue is almost 12%, net profit around 9%, normalised earnings per share around 9.5%, and the dividend almost 10%. Meanwhile, the operating margin is running just over 16% and the return on capital is a little over 25%. I think these numbers suggest a quality operation and investors have been rewarded with an increase in the share price over the period close to 270%. Wow!
A better business
I think Diploma is more than just your average distributor. The firm reckons its businesses offer “a blend of high-quality customer service, deep technical support and value-adding activities.” The aim is to deliver “essential solutions, not just products,” enabling the company to build strong long-term relationships with its customers and suppliers, “which support attractive and sustainable margins.”
I think the directors could have been looking across the pond for inspiration because they “encourage” an entrepreneurial culture in the firm’s individual business units by operating a decentralised management structure. That’s just how well known investor Warren Buffett runs his company Berkshire Hathaway in the US. Diploma argues that the arrangement allows decisions to be made close to the customer so that the businesses are “agile and responsive to changes in the market and the competitive environment.”
In today’s full-year report, the company presented another good set of figures. Year-on-year revenue increased 7%, free cash flow moved 9% higher and adjusted earnings per share rose by 13%. The directors pushed up the total dividend for the year by 11% reflecting their “confidence in Group’s prospects.” Indeed, the outlook is positive and the company expects to grow further both organically and by acquisition, as it consolidates further into what looks like an attractive trading niche.
I think Diploma has many fine qualities and is worth keeping a close eye on with a view to buying some of the firm’s shares.