Tuesday, July 10, 2012

James Halstead Plc - Specialist Flooring

James Halstead (JHD) manufactures and distributes upscale branded flooring products for commercial, contract and domestic use – in hospitals, laboratories, hotels, retail stores, offices, swimming pools, buses, offices, and homes.   The business is managed and majority-owned by the fourth generation of the founding Halstead family.

The company is small, unlevered, consistent, profitable, and growing. It is a specialist operator that seems likely to benefit both from three long-term market trends: an increasing preference for hard flooring over carpets; the displacement of basic hard flooring by luxury, high-performance, and aesthetic varieties; and the increasing demand for “green” products.

There are flooring products manufacturers many times JHD's size, but their focus is diffuse, their commitment to research and development unsteady, their debt burdens large, and their strategic ambitions likely to be limited to the quest for solvency, cost-containment and scale.  

Contrasting the financial statements of Mohawk Industries or Armstrong Worldwide, the two largest flooring products manufacturers, with those of James Halstead will bear out the intuition that, in the contest between the specialist and the generalist, the specialist will hold its own – it will have higher quality products, higher margins, lower costs, better relationships with distributors and buyers, shorter cash conversion cycles, and stickier business.  

And, with each iteration of the competitive cycle, the specialist's advantage should widen: the brand's reputation strengthens, sales rise, third party distributors  move their inventory faster, pricing power improves, cash conversion accelerates, R&D is better funded, technically superior products are manufactured, and the cycle begins anew.

This is James Halstead's ten year history:

and this is the relative performance of the three firms over the last business cycle:

Consistent with this portrait of success, James Halstead's management projects confidence: in the last ten years, it has paid out 60% of operating profit to shareholders, and invested the remainder, harvesting 45% annual returns on that incremental investment.  

If JHD does only maintenance business from now on, it can be relied on for £37 million per year in operating profit: normal ROIC of 45.8% x £81.4 million installed operating capital.

Given the quality of James Halstead's business model, the predictability of its financial results, and the size and steadiness of its payouts to shareholders, normalized profit should be capitalized using a 7% rate to place value of £529 million on the enterprise. (Another way of saying this is that JHD deserves an unlevered operating P/E of 14.5x; as a point of  reference, the UK’s PE-10 is 15x).  

After subtracting £25.5 million in debt equivalents and adding back both the £34 million in cash and the £10 million tax shield on debt, the equity is worth £546 million, or 530p per share. 

Revenue growth would add substantial value: a 5% rate of growth in revenue over the next ten years adds £339 million to the present value of the enterprise -- a 64% upside; 10% growth, in line with the prior decade, adds  £740 million -- a 140% upside. 

Disclosure: I have a position in JHD

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