Halma offers the right answer for shareholders yet again

“Forty-two was, according to the Deep Thought computer in the Hitchhikers’ Guide to the Galaxy, the answer to Life, the Universe and Everything but shareholders in Halma will be pleased to see to FTSE 100 firm fulfil their more prosaic, financial needs with its forty-second consecutive increase in its annual dividend of at least 5%,” says AJ Bell Investment Director Russ Mould.

“This increase comes after 2% advance in (adjusted) earnings per share (EPS), excluding the gain on the sale of the Fiberguide business, which is testament to the resilience of the company’s business model, even in the face of an extremely testing backdrop.

Chart - NYSE data to February 2010, FINRA data from February 2010

Source: Company accounts, Marketscreener, consensus analysts' forecasts. Financial year to March.

“Adjusted earnings per share fell 6% year-on-year in the first half, so the second half showed 10% growth, as organic sales came in flat in the second six months of the fiscal year after an 11% drop in the first six.

Chart - NYSE data to February 2010, FINRA data from February 2010

Source: Company accounts. Financial year to March.

“That momentum appears to be carrying forward into the new financial year, albeit unevenly across the company’s geographic and product segments, with China and Asia-Pacific leading the way, the US and Europe stabilising and the UK still lagging.

“Chief executive Andrew Williams’ outlook statement also flags a recovery in the company’s book-to-bill ratio, as order intake again exceeds revenues.

“That underpins the board’s decision to increase the final dividend by 8% and the annual dividend by 7% to 10.78p and 17.65p respectively.

Halma is still making a 21% operating return on sales, a double-digit return on invested capital (ROIC) and generating plenty of free cash flow. In addition, net debt is low at £315 million given the cash flow and shareholders’ funds of £1.1 billion while earnings cover for the dividend payment is nearer three than it is the traditional comfort zone of two. Halma can afford to maintain its dividend growth streak, so long as management feels it is prudent to do so and it does not have a more pressing use for the cash elsewhere.

Chart - NYSE data to February 2010, FINRA data from February 2010

Source: Company accounts, Marketscreener, consensus analysts’ forecasts for 2022E. Financial year to March.

“Although the actual forecast dividend yield of 0.7% is not going to set income investors’ pulses racing, the consistent increases in the total annual pay-out are helping to carry the share price higher. Halma’s share price was 1.9p at the start of 1979, when the dividend growth streak began, so this year’s forecast distribution of 18.5p a share looks pretty good against that.

“While this might seem like an extreme example, it does show how well-run, well-financed companies which build and hone their competitive position can reward truly patient investors, with the ideal combination of capital gains and income. Halma has been able to do this, and keep that dream alive, because management continues to get the fundamental basics right:

  • The company continues to think on a long-term basis, with careful investment in new products and services and prudent capital allocation. Investment in organic growth comes first, select acquisitions second and capital returns to shareholders next, which is the correct way around. If the first two are done well, then the third can almost take care of itself.
  • There are strong regulatory drivers associated with Halma’s hazard detection and life protection products and the company’s ongoing investment means it continues to maintain and develop the competitive position of its core business. Both facets are reflected in the high-teens percentage operating margin and the robust strong cash flow which both funds the dividends and keeps debt reassuringly low.
  • Management continues to use select, small acquisitions to supplement existing momentum within the business, not create or transform it with one knock-out, potentially high-risk deal.

“One challenge that shareholders do face now is Halma’s valuation. A forward price/earnings ratio of more than 40 times prices in an enormous amount of good news, even allowing for the company’s long-term track record.

“The one danger is therefore that investors mistake the reliability of Halma’s business model for safety, in that the higher the valuation goes, the less safe the shares may be, at least in the short term.

“Valuation is the ultimate arbiter of investment return is Halma is gently lagging the wider UK market. Since Pfizer Monday last November, its shares are up by 7% compared to 21% surge in the All-Share index

“This is because investors still seem to be preferring cyclical names, with recovery potential, to more reliable, consistent performers. This is because cyclicals have done less well for the thick end of a decade and are generally cheaper, while they also offer the prospect of faster near-term earnings growth if the pandemic is truly beaten off and the global economy starts to motor.

“Long-term investors are unlikely to be moved by such considerations and will no doubt ride out any cyclical eddies and whirls in the view that Halma’s business model, strong cash flow and robust finances will enable the company to add to its long-term dividend growth streak which, by dint of mathematics, could keep dragging the shares higher if it does indeed continue.”

These articles are for information purposes only and are not a personal recommendation or advice.

The chart of the week is written by Russ Mould, AJ Bell’s Investment Director and his team.

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