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Headlam Group plc

INTERVIEW: Headlam Group Shares are very good value say Zeus

Headlam Group Plc (LON:HEAD) is the topic of conversation with Equity Research Director at Zeus Capital Andy Hanson. Andy talks us through today’s interim and acquisition announcements, the effect it has on forecasts and the valuation.

Headlam Group Plc has released a trading update for the ten months to 31 October 2017 this morning. A weaker market backdrop has resulted in the moderation of top-line growth in H2 driven by softening in demand in the UK; despite this FY17 PBT is anticipated to be in line with market expectations thanks to well executed efforts to realise operational efficiencies. Headlam has also announced the acquisition of Domus Group, a leading UK specification consultant and supplier of hard surfaces for £35.4m (8.0x FY16 EBITDA). Whilst not immune to the wider market backdrop, Headlam’s market position, scale and ongoing efficiency initiatives gives it a degree of robustness, enhanced by the announcement of an earnings enhancing acquisition. Headlam currently trades on 12.9x FY17 earnings with an attractive 4.5% yield and a strong balance sheet giving the potential for additional acquisitive growth or further special dividends.

Growth moderating in H2 –  Total revenue for the first 10 months of FY17 is +2.7% YOY (1.7% CER), with LFL revenue +0.7% in the UK and 4.5% in Europe. This performance reflects moderating growth in H2 versus the 4.0% growth delivered in H1. Revenue in the first four months of the second half is +1.5% (0.6% CER). In the UK, LFL revenue declined 1.1% driven by a 2.6% drop in commercial revenue and a more moderate 0.4% decline in the residential sector. This was offset by a robust performance in Continental Europe with LFL revenue +6.6% including an impressive 11.3% growth in the residential sector. Current trading has shown a marginal improvement on the four months to October, but management now expect revenue growth for the full year will be marginally below consensus expectations. Despite this, FY17 PBT remains in line, thanks to gains in margin realised in the year. Headlam’s ability to meet profit expectations despite the challenging market backdrop highlight’s the strength of its offering and the success of its self-help initiatives.

Acquisition of Domus Group – Headlam has announced the acquisition of Domus Group, the UK’s leading specification consultant and supplier of hard surfaces for premium construction and refurbishment projects. In the year ended 31 December 2016, Domus reported revenue of £29.6m, £4.4m EBITDA and PBT of £2.9m. Total maximum consideration of £35.4m (cash free/debt free basis) is 8.0x FY16 EBITDA and comprises initial cash consideration of £29.4m funded through existing cash and debt facilities, deferred consideration of £3.3m and a further maximum contingent consideration of £2.7m, payable based on EBITDA targets over the three years to 31 December 2020. Domus complements Headlam’s existing business whilst broadening its position in the floorcoverings market. The acquisition is immediately earnings enhancing and will improve overall group margin mix.

Forecasts & valuation – We have adjusted our forecasts to reflect the moderation of top line growth in the core business and contribution from the acquisition of Domus. The net effect is an earnings upgrade of c. 8% and 10% in FY18 and FY19, respectively, see Exhibit 1 for detail. The share price has fallen from a high of 640p suggesting the market was expecting the performance of the core business to be worse than today’s statement indicates. Headlam trades on 12.9x FY17 earnings and offers an attractive prospective yield of 4.5%. The Group’s balance sheet is strong and there remains potential for further acquisitions or additional special dividends in the future.

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