In my search for industrial stocks that could benefit from the world’s focus on a cleaner future, I turned to the GuruFocus All-in-One Screener. Prioritizing the GF Score, the top two stocks were Ashtead Group PLC (LSE:AHT, Financial), scoring 93 out of 100, and Halma PLC (LSE:HLMA, Financial) with a score of 92.
Since we looked at Ashtead earlier this year, this discussion will focus on Halma.
The GF Score combines profitability, financial strength, growth, the GF Value rank and momentum. It is a useful metric to show how good a stock is all around. Stocks scoring between 91 and 100 have the highest outperformance potential based on backtesting data. I like it because it is a simple yet effective way to measure the key metrics of a company.
A high-quality company that makes health and safety instruments, Halma was named Britain's Most Admired Company in 2020. This is the longest-running peer-reviewed survey of corporate reputation in the U.K., run by the respected British business publication Management Today.
Year to date, the stock is down 26% in sterling terms, giving investors a chance to buy the dip. I call it a dip because since 2009 to the start of 2022, the shares rose more than 20 times.
As one of London's most consistent equities, the company has a market cap of just under 9 billion pounds ($10.3 billion) and sits firmly within the FTSE 100 Index. The stock is not a household name because it runs a conglomerate business model, owning a niche group of businesses that are business-to-business as opposed to directly selling to consumers.
The group is run like an investment company. It acquires highly profitable businesses in niche areas within the engineering sector. It looks for favorable and resilient long-term growth prospects, then uses its management expertise and economies of scale to help the acquired businesses grow. It then reinvests the profits these businesses make to acquire more companies and repeat the process. Halma is also managed conservatively, using retained earnings to fund acquisitions instead of relying on debt or equity finance. It lets the individual management teams run operations with minimal interference and the group has a strong track record of making the right purchases. The strategy is similar to Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial), but with a focus on industrial and engineering businesses.
Some of Halma’s products include smoke detectors, water treatments and health care and medical equipment. When looking for acquisitions, the company stays within its field of expertise, targeting manufacturers of products that protect people and the environment or those that help diagnose medical conditions. It is looking for structural drivers, products that are protected by patents and markets where regulation puts up barriers to entry. This is classic moat thinking. The resulting limited competition produces decent returns on capital and defensiveness in recessionary periods.
The attractive characteristics of the acquisitions have resulted in 19 consecutive years of record profit. By the end of 2021, the stock traded at 50 times forward earnings. In the market sell-off this year, that has come down to a more reasonable 30 times.
The decline was partly due to the market-wide sell-off given the outlook for a recession, but it is also partly due to some investors taking profits now that Andrew Williams, the longtime CEO, has announced he is stepping down next year.
This derating in the stock seems overdone given the company's track record of performing during difficult economic times. In June, it produced record revenue and earnings and in September, in a trading update, management said business is still going very strong.
Another reason for the decline, which has been speculated by the British business press, is that as Halma grows in size, it will be harder to find acquisitions that move the needle and that larger deals will bring more risk. It also means that any large acquisitions would start to dominate the proportion of earnings that any one business unit accounts for. While it is true it might be harder to find bargains when you are buying larger businesses, so long as management stays disciplined, and there is no reason to believe they would not, then I do believe Halma's growth can be mergers and acquisitions-driven. While there is a misconception that most M&A is bad, as we learned from the book, "Deals From Hell," these situations can be major catalysts for shareholder value creation as well as destruction.
As a result, I discount these concerns and see it as one of those situations where Mr. Market is giving investors a potential opportunity. I like that Halma's businesses operate in fields lacking strong competition and in markets which are defensive. Then there is the megatrend that certain engineering companies will enjoy in the environmental space.
In the September trading update, all of Halma’s segments delivered good organic constant currency revenue growth in the year to date and also benefited from its recent acquisitions. The largest inorganic contribution was from the Environmental and Analysis sector, which gives some credibility to my thesis.
Based on historical ratios, past financial performance and analysts' future earnings projections, the GF Value Line suggests the stock is modestly undervalued. Halma also scores well in my favourite financial strength metrics, with a Piotroski F-Score of 7 out of 9 and an Altman Z-Score of 8.36.
We will learn more next week how the company is progressing as the results for the half-year ending Sept. 30 will be released.
