Shares in Halma (HLMA) have fallen nearly 40% since the beginning of the year, putting the stock in the bottom quartile for performance among FTSE 100 companies. This means that shares in the company can now be bought at 26 times March 2024 earnings. This represents Halma’s lowest valuation in four years, and is roughly the same price to earnings multiple as 2016.

The chart shows how the shares have derated, and though it is based on historic earnings multiples the trend it reveals is the same.

Retail investors reasonably familiar with the company may find this startling, and several analysts share that sentiment. ‘In our view, Halma is a high-quality business with long-term growth and strong operating margins… we believe Halma is well placed to take advantage and one of the most resilient names in the sector,’ is what Shore Capital’s analysts wrote after analysing the company’s most recent full year results (to 31 March 2022) in June.

‘Halma is the best kind of predictable, with the full year 2022 results delivering the 19th consecutive year of record profit, the 43rd consecutive year of dividend growth of 5% or more, and record revenue,’ said analysts at investment bank Berenberg.

Put another way, Halma is exactly the type of company Terry Smith would likely consider buying for the Fundsmith Equity Fund (B41YBW7) if it had greater scale. Illustrating that point, as of June 2022, the Smithson Investment Trust (SSON), also part of the Fundsmith stable, had 2% of its assets tied up in Halma.

WHAT DOES HALMA DO?

Halma is a group of design and manufacturing businesses that provides health, safety and environmental monitoring equipment based in Amersham, Buckinghamshire. It’s a vast product portfolio that includes things like radiation hazard detectors, water quality monitors and fire safety kits and sensors.

By doing so it taps into non-discretionary spending often backed by regulatory and legislative drivers.

The company’s objective is simple. It aims to double its earnings every five years while generating strong returns on investment and equity. These latter metrics were approximately 14% and 19% over the past year, according to Investing.com data.

Growth is bolstered by bolt-on acquisitions that will feed the wider profits and cash generation machine. Two announced earlier this month (October 2022) are great examples.

First, US-based IZI was bought for $168 million. It designs and makes medical consumable devices mainly used by interventional radiologists and surgeons in a range of acute, hospital-based diagnostic and therapeutic procedures. Weetech followed just days later in a €57.5 million deal. It designs and manufactures safety-critical electrical testing technology, largely used to test the integrity of both high and low voltage electrical systems.

Where Halma stands apart from most other acquisitive businesses is through its decentralised culture. Rather than head office dishing out orders from afar, individual subsidiaries are given the freedom to make their own decisions, empowering local management and encouraging an entrepreneurial spirit.

This is a similar management structure employed by Warren Buffett and Charlie Munger at Berkshire Hathaway (BRK:NYSE), which has also done pretty well for investors over the years.

Berkshire and Halma also share a sharp focus on cash flows. Last year the UK company generated £278.9 million of operating profit (before any adjustments) from £194 million of fixed assets,
and 84% of those operating profits converted into cash flow.

Pre-tax profit (adjusted for acquired and sold businesses) rose 14% last year to £316.2 million on revenues of £1.52 billion, 16% higher on the previous year.

‘Organic constant currency revenue growth came from all sectors and across all major regions,’ noted Shore Capital.

RETURNS MASSIVELY TRUMP FTSE 100

It is an all-round strategy that has proved stunningly effective over time. Halma has delivered an average annualised total return of 12.7% and 18% over the past five and 10-year periods, according to Morningstar data. A FTSE 100 ETF would have returned something close to 2.2% and 5.5% respectively.

The announcement of chief executive Andrew Williams retirement in June this year may have added uncertainty for some investors, yet the company’s clear succession plan should soothe concerns. Williams, who has run Halma for the past 18 years, will be succeeded by Marc Ronchetti in April 2023, chief financial officer since 2018 and a Halma man for the past six years.

Berenberg analysts see no reason why Ronchetti cannot manage more operating and stock market success in future. ‘We expect an orderly transition process and more of the same Halma predictability in the future.

‘Halma’s focus on non-discretionary, regulatory-driven, structurally growing end-markets means it is far more resilient than many companies during economic downturns and we forecast record results to continue,’ they said.

According to the investment bank’s forecasts, Halma is set to grow operating profit and revenue 24% over the next three years, including the current 12 months, with operating margins remaining stable between 24% and 25%. The next few years could also see net debt wiped out from last year’s £213 million, potentially making extra cash available for faster growth in the dividend than the mid-single digits which is anticipated.

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