Today, Headlam Group released their last trading update before reporting their annual results in March 2018. In this article, I will cover the following aspects:
-Is the firm a long-term investment?
-Should you put the stock in your investment or ISAs portfolio?
-The earnings visibility.
-How does the firm compare with rivals?
-What is their dividend policy?
Interpreting their pre-close trading update
Management has stated the company recovered well during the Christmas period. It helped total revenue to grow by 2.1% or 1.2% constant currency.
The like-for-like sales growth are as follows:
They also acquired Domus Group for a maximum consideration of £35.4m (with the initial consideration at £29.4m).
But how did that compare to last year?
Well, total revenue grew by 6% and the UK was the main driver of growth with LFL growing by 4.7% vs. Europe’s 3.8%. It also pointed out that the UK makes up 88% of group sales.
When compared to last year, sales have slowed markedly and I would be interested what management has to say about the outlook in 2018.
What does the Headlam Group do?
Headlam is Europe largest floorcovering distributor, where most of their business comes from the UK.
The breakdown of regional financial performance is as follows:
1). Sales: – UK: £602m; Europe: £91.4m.
2). Operating Profit: – UK: £40.9m; Europe: £0.8m.
Not only the UK is dominating sales, it is earning 90% of the group’s profit. So, a slowdown in the UK market with 0.5% LFL growth could harm profit margin, although management says “underlying profit before tax of £42.5 million represents an uplift of 6.0% on the prior year comfortably.”
The Domus acquisition would help to grow Headlam’s sales and profit before tax by £29.6 million and £2.9 million, respectively in 2018.
I’m not saying all acquisitions are bad, we got to be smart about acquisition a company and the objectives behind their intentions.
Anyway, I like the acquisition because it is paid for by cash. Also, the price tag of £29m on a net profit of £2.32m is 12.5 times PE Ratio, which isn’t too demanding.
Now, let’s shift our focus to the long-term investment perspective of Headlam group.
Understanding the Dynamics of Sales and Profit
Headlam Group is a very mature business.
Since 1998, sales growth average 4.4% per annum.
But profit growth (aka post-tax profit) is worse than sales and register around 3.8% per annum, which means margins are declining.
Great investors don’t just look at growth from one period to the next, they identify business cycle trends. The CHART BELOW displays this.
So, the base year is 1998 and the line graphs measured the changes in sales and profit changes vs. 1998. Also, I added an area graph on the changes to its share price.
The fascinating thing with a maturing business like Headlam is profits need to decline for more than one period to fundamentally adverse its share price. That odd decline in profit in 2013 may have slowed its share price a tad, but once profit growth resumes the share price momentum continues.
According to 5 brokers, they are forecast post-tax profit of £34.7m in 2017, £38.3m in 2018 and £39.5m in 2019.
That is optimistic, but what about the floorcovering market, especially in the UK?
Well, Headlam has stated in their annual report that the market for floor covering in the UK will grow from £1.94 billion in 2016 to £2.17 billion in 2020, an increase of 11.9%.
Remember these aren’t facts but are forecasts and we should take it for reference purposes. These forecasts can be way off if UK economy decline or exceed expectations.
Let’s discuss Headlam rivals.
Are their rivals to Headlam Group?
When it comes to the distribution of floor covering products, Headlam Group is the biggest distributor in Europe. Also, Headlam has a tendency to buy up smaller rivals like Hickson plc, West Fife Flooring, Lethem-Vergeer and others.
But what I like about Headlam is their outperformance vs. the manufacturers and sellers of floorcovering businesses like Carpetright, Topps Tiles, United Carpets and possibly Scs group.
Also, Headlam has the simple task of delivering floorcovering from point A to point B. All they need are a few warehouses, drivers and lorries.
The business model is that simple!!!
It is so simple that over the past ten years, Headlam Group is beating the floorcovering businesses in terms of share price appreciation.
(If you can’t see the chart clearly, then head over to Stockopedia and compare Headlam with Carpetright, Topps Tiles, United Carpets and Scs group.)
In the next section, we talk about dividends.
Headlam Group the progressive dividend payer in a normal economy
Graham Neary likes Headlam superior dividend and its large yield. If you look at its dividends payout over a longer period, then Headlam has been a consistent payer when the economy is operating normally.
I made several notes on the chart, first the average share price number is for reference purposes, given the nature of floorcovering market which relates closely to the housing market, especially changes to housing transactions per year.
The second point is more important when Headlam paid out £2.99 per share in dividends since 1998 because it proves consistency and competitiveness of business.
For instance, if you are a shareholder in Headlam since 1998, you would have purchased your shares at an average price of £2.42. That means Headlam would have returned your original investment and more.
We shouldn’t forget about the share price appreciating to £5.80 per share, giving it an unrealised gain of 140%.
In total, you would see gains of 263% return.
You know inflation would erode some of your returns over this period and since 1998 the cost of living has risen by 73%.
So, the real return is 190%.
Compare that to the FTSE All-Share Index of 58% gains and wouldn’t have covered the power of inflation.
Also, a progressive dividend payer means you will enjoy increasing dividend yield and last year payout is equivalent to 12.6% if you held on to the stock since 1998!
The size of the dividend payout depends on the size of your original investment.
The worst-case scenario possible for Headlam Group
As I said, Headlam isn’t immune to changes in the business cycle.
But what is the worst can happen?
The company faced two downturns in their share price when it declined between 1999 and 2000 (-71%), also between 2007 and 2008 (-70%).
On each occasion, Headlam made new highs, unlike Carpetright, Topps Tiles and United Carpet Group.
But in both these occasions, the financial markets were in turmoil.
Where will the share price go?
It is likely the HELP to Buy will be extended to 2021, this increases the chance of more people doing housing transactions.
Also, the forecast for housing transaction is likely to grow from 1.08m per year to 1.21m per annum by 2021, according to Statista.
Assuming it achieves a post-tax profit of £39m by 2019, then applying the current PE Ratio of 15 times, would give a valuation of £585m or £6.96 per share price.
But if there is a genuine weakness in the UK housing market, regardless of help from the government, then Headlam would experience a big share price decline, but fundamentally it will recover.
Finally, is Headlam good for your investment portfolio?
Whether it’s good for your portfolio or not, Headlam Group is more stable with more predictability earnings visibility than the likes of most floorcovering businesses like Carpetright.
If a recovery takes shape it will be the first company to recover due to the lack of competition distributing floorcovering.
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