When Covid shut production lines across industry, Halma suffered just a blip in sales. Yet amid the current economic downturn, the manufacturing group has been priced for a worse slump.
The shares trade at 23 times forward earnings, a pumped-up multiple by the standards of the rest of the FTSE 100’s constituents. But it is at a six-year low and a discount to the depths of the pandemic. No stock is recession proof, but Halma’s defensive credentials still stand.
There is a reliability to its earnings stream and high barriers to entry in the niche, regulation-driven end markets that it sells its components to. Its portfolio of 48 companies designs and makes products for safety and hazard detection uses in three main divisions: safety, medical and environmental and analysis. Its products include blood pressure testing monitors, fire detectors and water quality testing equipment.
After the 2008 financial crisis, organic revenue and profit growth were quelled but not killed. The former was up 2.5 per cent in 2009 and the latter rose 5 per cent.
Halma has lofty targets. It aims to double post-tax profit every five years, which requires average annual revenue growth of 15 per cent. It is not there yet. Profits after tax rose by 68 per cent in the past five years. Impressive, given it includes the pandemic, when project-based work was deferred and accessing installation sites became difficult.
At a minimum it is seeking to grow the top line 10 per cent a year, split evenly between organic means and acquisitions. That is a target it has exceeded. Over the past decade revenue has grown at a compound annual rate of 12 per cent, while adjusted post-tax profits, its preferred measure, have risen at 11 per cent.
The idea is to first capitalise on structural catalysts for its products — decarbonisation, increasing health and safety regulation and ageing populations, to name a few. Taking market share is a finite avenue for growth. Instead businesses try to push the edges of their end markets, either expanding internationally or through new product lines.
Halma has a good record of buying businesses well. Acquisitions are by self-funded cash generation. An acquisition a month before the last annual accounts were signed off pushed leverage to just under 1.4 times adjusted earnings before interest, taxes and other charges. That was only the third time in a decade leverage has risen over a multiple of one. Analysts think it will fall to 0.9 by the end of March 2024.
Its return on invested capital has consistently outweighed its weighted average cost of capital, a 14.8 per cent/ 8.9 per cent balance last year despite interest rate rises.
Weaker demand from customers in the life sciences sector means the return on sales — pre-tax profits as a proportion of revenue — is expected to be at the lower end of an 18 to 22 per cent target range (after debt payments) during the first half of this year. Healthcare companies are also running through stocks piled higher during Covid, a trend that is thought likely to start petering out towards the end of the year. Analysts have forecast a slowdown in revenue and post-tax profit to 6 per cent this year.
Revenue visibility is low. Orders are made only 10 weeks before delivery. But the value of the order book has kept up with revenue, which indicates that demand is remaining relatively healthy.
If demand does falter, there is scope to take out costs, namely, headcount at its facilities and the cost of goods used in manufacturing. This helped push Halma’s return on sales punch near the top of its target range during the pandemic.
Its ability to weather past downturns should reassure investors it can do so again.
ADVICE Buy
WHY The shares’ discount does not reflect its defensive qualities and track record
Ithaca Energy
Investors in North Sea oil and gas companies are no strangers to having their fingers burnt. Ithaca Energy has yet to convince investors that it can avoid coming unstuck.
Its shares are priced at about a third below their IPO price at the end of last year. An enterprise value of just 1.7 times forecast earnings before interest, taxes and other charges makes Ithaca more cheaply valued than majors such as BP or Shell.
Ithaca has the benefit of a credible, heavyweight backer, majority owned by the Israeli conglomerate Delek. The group took the company private in 2017, before launching it back onto the London market at 250p a share.
The company focuses on acquiring assets either already in production or in development. By eschewing exploration, the business model has the potential for less risk. But it also means it needs to keep searching for new assets to replace maturing wells. Its reserves can sustain production over the next 19 years after allowing for run off. That does not include its 20 per cent stake in Rosebank, which was controversially approved for development last week. The field, due to start production at the end of 2026, has the capacity to produce over 20 years.
Commodity price fluctuations are a risk. The direction of regulation is the other, in particular whether the decision to grant new oil and gas licences is repealed. Then there is the risk of more punitive taxation. In August, Ithaca said it expected to invest less in production this year as a result of the windfall tax.
The oil price rally has boosted cash generation, which came in at $420 million in the first half of the year. It has hedged around two thirds of its production at $73 a barrel over the second half of this year, way above its $19.8 a barrel cost of production. It has also hedged 55 per cent of the production forecast by Peel Hunt at between $75 and $77 a barrel. Meanwhile a leverage ratio of 0.35 is well below a target ceiling of 1.5.
Analysts have forecast another beefy dividend of 26.6 cents a share next year, which translates to a potential yield north of 10 per cent at the current share price.
The cash rewards in the near term should compensate shareholders for enduring political risk.
ADVICE Hold
WHY Generous dividend yield but regulatory risk persists
