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Headlam Group plc

Headlam Group plc Strong trading leads to further upgrades to forecasts – Zeus Capital

Headlam Group plc (LON:HEAD) saw strong trading in the last eight weeks of the year lead to further upgrades to forecasts, this follows the upgrades put through at the time of the ten-month trading statement on December 1st. Revenue forecasts increase slightly, c. 1.0%, in FY16 to £693.5m (prev. £689.0m), showing 6% yoy growth (FY15: £654.1m). This is magnified at the operating level due to the August price increase in the UK leading us to increase margin assumptions at the operating level by 30bps. As a result, PBT increases 7.0% to £40.1m (prev. £37.5m) and equates to c. 13% yoy growth. Our FY17 revenue forecast increases to £710.8m (prev. ££695.9m) and, again with the benefit of operational gearing, leads to a 10.7% increase in PBT to £42.7m (prev. £38.6m). FY18 forecasts remain conservative with just 1.0% revenue growth assumed but the flow through from the higher base in FY17 means earnings forecasts increase c. 10%. Despite wider equity markets having been buoyant, Headlam shares are up only c.2% since the increase to forecasts in December. Post today’s upgrade, the shares on just 12.0x FY17 earnings and offer a 4.4% yield. Appealing, considering Headlam’s best in class performance during the year.

* Excellent performance during the year – Industry forecasts assumed the market would grow 3.6% in 2016, we believe this might prove optimistic putting Headlam’s like for like performance of 4.7% in context. The final quarter’s like for like performance of 6.3% also bodes well for the early part of FY17 and underpin our confidence in today’s upgrade. Reassuringly both parts of the UK business performed with the Commercial division showing solid growth in H2 post a slower H1. However, it has been the Residential division that has underpinned the group performance benefiting from price increases and a beneficial product mix. In addition to the UK business, the European operations also had a solid year. In comparison peers, we believe Headlam has materially outperformed peers and taken market share in 2016. This has resulted in 12.6% earnings growth yoy.

* Earnings upgrades driven by operational gearing – The combination of price increases on volumes that have remained firm has meant profitability has benefitted from operational gearing. As a consequence, a 0.7% increase in revenue leads to a 7.1% increase in profitability as FY17 PBT increases to £40.1m. In FY18 the yoy revenue growth assumption increases to 2.5%, from 1.0%, leading to a 10.7% increase in earnings, followed by 10.3% in FY18. Our net cash number for FY16 remains flat at c. £36.0m due to £2.0m of exceptionals in the year.

* Valuation – The Headlam Group plc FY17 earnings multiple of 12.0x is below the 13.4x ten-year average. On this multiple shares would trade at c. 540p, c. 12% above last night’s closing 483p. Arguably, the business deserves a premium rating for delivering growth significantly ahead of the market driving earnings upgrades. On 15x the shares would trade at 603p, offering c. 25% upside.

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