Introduction
Halma p.l.c. (OTCPK:HLMAF, OTCPK:HALMY), the U.K.-based technology and safety equipment company, recently published its full-year results for fiscal 2024. The market, which has shunned HAMLY shares for two years now, clearly liked the results, as evidenced by the sharp rise following the results.
As a U.K.-based company with a current market capitalization of £10 billion (around $12 billion), Halma is rarely covered here on Seeking Alpha – unfairly in my view. I firmly believe that Halma is one of the best-managed companies in the world, operating in several industries that are benefiting strongly from secular growth drivers such as the transition to alternative energy sources or the ever-increasing regulatory requirements around safety and hygiene.
In my last article, which was published in May 2023, I analyzed Halma’s performance during the Great Recession. For this reason, and because of the recently published fiscal 2024 earnings report, I think it’s a good time for an update. In what follows, I’ll discuss Halma’s performance in fiscal 2024, highlight some aspects underlying the company’s long-term success and provide an updated valuation.
Let’s dive right in…
Halma’s Fiscal 2024 Earnings – There’s A Lot To Like
Fiscal 2024 was a very strong year for Halma. Sales increased by 9.8% year-over-year to £2.03 billion (Figure 1). Importantly, five percentage points of organic growth at constant exchange rates was attributable to volume. I believe this is strong evidence of Halma’s world-class position in the sectors in which it operates (see my first article for a business breakdown), partly because the company was also able to implement price increases, resulting in an additional three percentage points of organic sales growth. Including acquisitions, currency-adjusted sales grew by 12%, slightly offset by a currency headwind.
Figure 1: Halma: Annual revenues and year-over-year change (own work, based on company filings)
Now, one could argue that growth through acquisitions is extremely difficult, with the biggest challenges being sound due diligence in terms of fit and quality, making sure not to overpay, and of course, proper integration. However, Halma is a prime example of a company that has a knack for acquisitions.
One important aspect is that the company is still small enough. With current annual sales of £2 billion and EBITDA of around £480 million, acquiring small, little-noticed or privately owned companies still moves the needle. The due diligence that precedes the acquisition of smaller – often founder-led – companies is much more manageable than for large acquisitions. In fiscal 2024, Halma made eight acquisitions, one more than the previous year, paying an average of £37 million per company.
A major aspect that distinguishes Halma from its competitors is the fact that management maintains a very liberal relationship with the executives of the acquired companies. Of course, key performance indicators are set, but the subsidiaries are largely able to retain their entrepreneurial freedom. Therefore, I think it is important to keep an eye on how many companies Halma acquires and sells each year, and it is also a good idea to maintain a list of the name of the acquired companies in order to spot an increasing turnover rate. Even though I realize I come across as skeptical in this context, I would like to reiterate Halma’s strong corporate culture and point out that I only monitor such statistics for the purpose of proper due diligence. I do not want to give the impression that I think it is appropriate to distrust Halma’s management.
In terms of operating earnings, year-over-year growth of around 12% was even stronger than sales growth. Acquisitions were responsible for more than 50% of growth at constant exchange rates. Halma generated an adjusted operating profit of £424 million in FY2024, which translates to a very strong operating margin of 21%. This is very much in line with the historical average operating profitability of 21%. Free cash flow for the year, after accounting for stock-based compensation as a cash expense but before normalizing working capital movements, was £306 million, which equates to a free cash flow margin of 15% (more on this shortly).
Note, however, that the company reports its operating profit on an adjusted basis, which means that it excludes amortization and impairment of acquired intangible assets, restructuring costs and other items from the reported figures. On a reported basis, Halma’s operating profit in FY2024 was 13% lower than on an adjusted basis, similar to FY2023 where the difference was around -18% (Figure 2).
Figure 2: Halma operating income before and after adjustments (own work, based on company filings)
I am generally not a big fan of such significant adjustments, but in Halma’s case I am happy to give management the benefit of the doubt due to the consistently very strong track record and low volatility of these adjustments. The main adjustments relate to the amortization and impairment of acquired intangible assets. However, I found it difficult to distinguish the percentage of amortized from impaired intangible assets in Halma’s report.
As a result of these recurring adjustments, the earnings-based valuation metrics published on most, if not all, platforms make Halma’s stock look cheaper than it actually is – and HLMAF is already known for its generally quite high valuation. In concrete terms, the stock currently trades at a P/E ratio of 31, based on adjusted EPS for fiscal 2024 of 82.40 pence. On a reported basis (71.23 pence), it trades at a P/E of 36. Knowing how important acquisitions are for Halma to maintain its growth, I am leaning towards the latter valuation, as I think it reflects reality better than the former.
However, instead of operating profit, I consider free cash flow to be a better measure of actual earnings power, also against the background of assessing the safety of dividends. Furthermore, a healthy free cash flow allows a company to grow sustainably without having to take on excessive debt. In this context, I think it is worth appreciating the fact that Halma has a healthy balance sheet, which is underlined by its current leverage ratio of 2.5x adjusted free cash flow or 1.2x adjusted EBITDA (Figure 3).
Figure 3: Halma’s leverage in terms of adjusted free cash flow and adjusted EBITDA (own work, based on company filings)
However, do note that the leverage ratio and net debt increased in fiscal 2023 and remained unchanged compared to the previous year (Figure 4). While I doubt that management has changed its long-term strategy towards a more leveraged balance sheet, I think it is definitely advisable to keep an eye on these figures going forward.
Figure 4: Halma’s net debt and discounted lease liabilities (own work, based on company filings)
Coming back to free cash flow, fiscal 2024 was another strong year for the company, with growth of more than 50% year-over-year on a conventional basis (blue bars in Figure 5) or around 10% when adjusted for working capital movements (red bars). It is in the nature of things that free cash flow is more volatile than operating profit, so I base my own assessment on the figures adjusted for working capital.
Free cash flow growth is in line with the growth in operating profit, and the long-term growth trajectory remains fully intact. Since fiscal 2014, Halma’s adjusted free cash flow has grown by 11.4% per annum, which is almost exactly in line with the 11.7% per annum growth in adjusted operating profit. Growth based on reported operating profit was de facto identical, which is good to see. A significant deviation would indicate likely unsustainable growth rates that are not supported by cash flows.
Figure 5: Halma’s free cash flow, before and after smoothing of working capital movements (own work, based on company filings)
Conclusion
All in all, I think it is fair to say that this was another strong year for Halma. The continued double-digit growth was great to see, especially against the backdrop of a challenging macroeconomic environment and temporary weakness in its Healthcare segment (0.6% revenue decline). Growth in the Environmental & Analysis and Safety segments was strong at 19.3% and 10.5% revenue growth year-over-year.
Halma’s management fosters a unique corporate culture, which, I believe, is the central pillar of the company’s decade-long success. Sustainable growth through acquisitions and internal development is not easy to achieve – but Halma is definitely a positive prime example in this respect.
Not only did Halma record strong revenue growth, but also very solid profitability – both from an earnings and a free cash flow perspective. Of course, free cash flow is more volatile than earnings due to working capital movements, but the long-term growth trajectory remains fully intact.
Halma’s recent 7% dividend increase is the 45th consecutive year of dividend growth of at least 5%. Against the background of robust earnings and cash flow growth and, above all, a conservative capital structure, I have no doubt that this strong trend will continue (Figure 6). Therefore, I consider the dividend income generated from an investment in Halma shares to be more than adequately shielded against inflation-induced erosion of purchasing power – even I, personally, think a “higher-for-longer” scenario (in terms of inflation) is likely.
Figure 6: Halma’s annualized dividend per share and year-over-year growth (own work, based on company filings)
However, this does not (unfortunately) mean that Halma shares are a good investment today. Based on adjusted earnings per share for fiscal 2024 of 82.40 pence and a current share price of around £25.6, Halma shares are trading at a fairly high price-to-earnings ratio of over 30. A long-term growth rate of around 12% gives a similarly high PEG (price-to-earnings-growth) ratio of 2.5, while the adjusted free cash flow yield of 2.6% and the starting dividend yield of just 0.84% are not really convincing either. Even if Halma continues to grow its dividend by 7% per year – which I think is very likely given its strong fundamentals and a payout ratio of only 30% in terms of free cash flow – I don’t think the stock is a good income-generating investment. According to Figure 7, it would take 20 years for Halma shares to reach a yield on cost of 3.0%. Clearly, Halma is a total return investment.
Figure 7: Halma’s yield on cost scenarios (own work, based on company filings)
I am patiently keeping Halma on my watch list due to its excellent corporate culture, sustainable growth through disciplined acquisitions and internal development, and healthy balance sheet. I don’t like to overpay for my investments, but I am happy to pay up for quality. Therefore, I can see myself opening a position in Halma at £20 or less, which equates to a P/E ratio of 24, a free cash flow yield of 3.5% and a starting dividend yield of 1.1%. From a discounted cash flow (DCF) perspective, the market currently expects Halma to grow at 6.1% in perpetuity, at a cost of equity of 8.8% (Figure 8). While this is not unrealistic, I, personally, tend to be a little more conservative with my long-term expectations (bear in mind the notorious sensitivity of DCF models to the implied growth rate).
All in all, I see Halma as one of those high-quality companies that rarely trades at a compelling valuation, so I’m following a similar buy strategy to Procter & Gamble stock (PG, see my last article).
Figure 8: Halma p.l.c. (HLMAF, HALMY): Discounted cash flow sensitivity analysis (own work, based on company filings and own estimates)
Thank you very much for reading my latest article. Whether you agree or disagree with my conclusions, I always welcome your opinion and feedback in the comments below. And if there’s anything I should improve or expand on in future articles, drop me a line as well. As always, please consider this article only as a first step in your own due diligence.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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