If we conducted a straw poll we’ve no doubt most readers would have heard of Amersham-based engineering firm Halma (HLMA), but we suspect a much smaller proportion could put their hand up and explain what it does.

For a FTSE 100 company with a market cap of £8 billion, Halma seems to operate ‘in the background’ rather than taking centre stage so we thought it was high time we took an in-depth look at what makes the company tick.

A ‘GLOBAL SPECIALIST’

Halma calls itself ‘a global group of life-saving companies’, but what does that mean exactly?

Employing over 7,000 people in more than 20 countries, the group is a collection of around 45 different businesses providing technology-enabled health, safety and environmental solutions.

Its safety technologies protect people and the places they work, both in the private and public sectors.

Across 20 companies, the group provides fire detection and control, elevator safety and communications, electronic components testing for the aerospace and rail industries, and explosion vents and pressure sensors which help prevent catastrophic failures for sectors like oil refining, petrochemicals, biotechnology and even food and beverage manufacturing.

Its health care technologies, provided by more than a dozen companies, help contribute to the diagnosis and treatment of patients, data analysis and even the discovery of new cures.

Lastly, its environmental technologies, again offered by more than a dozen companies, monitor the environment, detect gas leaks, provide laboratory services and analyse materials in a wide range of applications.

It’s unlikely many of us have ever heard of any of these companies, yet what they do is largely essential to our everyday lives.

WHAT IS HALMA’S ‘DNA’?

The firm claims it has ‘organisational genes’ which run through its business at every level – a set of core elements or principles which have proven themselves fundamental in driving the firm’s consistent, long-term growth.

At its heart, the group is a collection of ‘global specialists’, targeting highly specific, high-return niches in markets with a positive impact and long-term drivers.

Each company is managed by its own board and makes its own decisions about how to grow its business so as to balance short-term profit with long-term growth.

Halma as a whole grows by investing in its companies while at the same time looking for ‘good businesses in markets with long-term growth drivers’ aligned with its way of thinking and ‘inviting them in’.

This can be by way of acquisition, or it can be through strategic partnerships where the other company retains its independence but benefits from Halma’s reach and resources.

In 2023 alone the firm has made five acquisitions ranging from a laser technology company which stops press-brake machinery when a worker gets too close (safety), to a high-tech sewer pipeline repair business (environmental) and most recently a company which makes advanced medical access systems for use in spinal surgery (health).

None of these deals have been big enough to ‘move the needle’ in terms of results, but all are highly complementary and demonstrate Halma’s deep-rooted belief in buying into high-return niche markets.

HOW IS THE COMPANY PERFORMING CURRENTLY?

In the six months to the end of September, with little fanfare and despite what has been widely acknowledged as a ‘challenging’ economic backdrop, Halma reported record sales, profits and dividends to its investors ‘while further enhancing our growth opportunities through increased strategic investment, supported by a strong cash flow performance and continued balance sheet strength,’ according to chief executive Marc Ronchetti.

‘We remain on track to make further progress in the second half of the year and to deliver good organic constant currency revenue growth in the full year to March 2024,’ added Ronchetti.

Notably, group order intake remains ahead of the comparable period last year and close to revenue in the year to date, while cash conversion was an extremely healthy 96% and net debt was just £619 million, or 1.4 times EBITDA (earnings before interest, tax, depreciation and amortisation), leaving plenty of scope for investment in organic growth and for acquisitions.

AN UNDER-RATED GROWTH STOCK

When we look at the earnings history of most companies we can see that they are often fairly cyclical, that is earnings rise and fall with the broader economy or with underlying commodity prices.

That is the case for example with banks, retailers, industrial companies, miners and energy producers, which make up a good percentage of the FTSE 100 index.

When we analyse a company’s earnings to try to determine its underlying growth rate, we adjust for the ups and down by using a rolling 12-month average which gives us a ‘cyclically adjusted’ earnings per share figure.

By fitting the cyclically adjusted earnings series to the actual earnings, we can see not just whether the company grows but how fast it grows over long time periods and how cyclical earnings are.

The remarkable thing about Halma, however, is not only is it a non-cyclical business, but its cyclically adjusted earnings and its actual earnings are almost identical, which means investors can have a high degree of confidence in where profits are going to be in three- or five-years’ time.

Looking at the chart above, we can see the firm’s earnings have continued to grow, with one or two flat years but no actual down years, since as far back as 1980.

In fact, we calculate the firm has increased its earnings per share over 40-plus years at an average compound annual growth rate of 13.6%, far in excess of the FTSE 100 average, and it’s done that with very little variation or volatility.

This makes Halma one of the most under-appreciated growth stocks in the market and is undoubtedly down to management’s understanding of the value of operating in essential niche markets across the globe where competition is limited and returns are therefore significantly higher than normal.

To show how resilient the group is to external factors, even during the pandemic earnings per share barely budged and in fact by June 2021 they were already above their previous peak.

SURELY THAT MEANS THE SHARES ARE EXPENSIVE?

Naturally, you would expect a company which grows its earnings so quickly and so consistently with so little volatility to command a hefty price tag.

However, thanks to the general sell-off in UK stocks since the pandemic, Halma shares now trade almost one standard deviation (a measure of divergence) below their historic average PE based on cyclically adjusted earnings.

In other words, at the current price the company trades on the same rating, around 25 times earnings, it did in 2011 coming out of the great financial crisis when annual earnings were around a third of today’s level.

It’s worth noting that between 2011 and 2020, the shares didn’t just recover to their long-term average, they hit 50 times earnings or almost one standard deviation above their average.

Therefore, assuming the company’s growth model and its track record of compounding earnings aren’t broken – and we very much doubt that is the case – investors are being gifted the opportunity today to buy into one of the most innovate yet least-appreciated companies in the FTSE 100 at a substantial discount to fair value.

Given the firm’s long-term ability to grow its earnings at a double-digit rate, we suspect consensus forecasts for the next few years are conservative, meaning there should be upgrades to come which will help with the rerating of the shares.

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