Halma - FTSE 100 darling or overpriced lemon with bloated balance statement

[TheMotorcycleBoy]

So being new to the private investing game, I like to look for the odd new holding to add to our portfolio. Sometimes I have a gander either at UK Buffetology or Smithson et al. and see what they have as a source of ideas.

I decided recently to look at Halma (HLMA) which is included in the much-revered Smithson fund:

https://smithson.co.uk/fund-factsheet

After doing some FA across years 2014-2018 for Halma, I'm probably going to give this company a wide berth.

There is so much Goodwill+Intangibles that P/TNAV is negative. They capitalise a lot of their internal development "costs", instead of expensing them. I believe this has the effect of inflating their Profit, and it makes them look more sexy on the cash-generation department, since they are then amortising these intangibles year-on-year and hence adding the amortised assets from in to the cash flow. For the year 2018

Profit After Tax: £154m
Amortisation: £43m

Hence amortisation is 28% the size of the PAT.

Does anyone else agree with my assessment of this company?

thanks Matt

[Alaric]

There is so much Goodwill+Intangibles that P/TNAV is negative.

Page 121 of the Annual Report.

Net Asset Value £ 000s 828,397
of which goodwill 632,162

There's not so much left if they were forced to write off all the "Goodwill".

But perhaps it will never happen.

[TheMotorcycleBoy]

There is so much Goodwill+Intangibles that P/TNAV is negative.

Page 121 of the Annual Report.

Net Asset Value £ 000s 828,397
of which goodwill 632,162

There's not so much left if they were forced to write off all the "Goodwill".

But perhaps it will never happen.

Intangibles 234,562

828,397 - (234,562 + 632,162) = -38327

i.e. negative tangible book value

They accumulate goodwill year on year I believe through continued acquistions. Here's an extended note 11 about the g/w on pg 148. I've not read it fully yet. Note 25 pg 167 reveals what relative portions of stuff is amortised. I've looked at all the ARs since 2014, and they all like this....I didn't like the look of it.

[TheMotorcycleBoy]

Valuations:

DCF assuming 8.5% CF growth for next five years, then 2.5% till perpetuity at discount rate 8% = £8.57
EPV assuming 75% of A&D is added to distributed cash, only 1% of sales value of outstanding cash balance is retained in business, financing costs ignored at discount rate 8% = £7.02

current market price = £13.41

I'm not going there....

[TheMotorcycleBoy]

Sorry, the title of the thread was supposed to be:

"Halma - FTSE 100 darling or overpriced lemon with bloated balance statement"

Bang goes the dramatic effect....

[77ss]

.....
I decided recently to look at Halma (HLMA)...

There is so much Goodwill+Intangibles that P/TNAV is negative. They capitalise a lot of their internal development "costs", instead of expensing them. I believe this has the effect of inflating their Profit, and it makes them look more sexy on the cash-generation department, since they are then amortising these intangibles year-on-year and hence adding the amortised assets from in to the cash flow. For the year 2018

Profit After Tax: £154m
Amortisation: £43m

Hence amortisation is 28% the size of the PAT.

Does anyone else agree with my assessment of this company?

thanks Matt

Is 28% a serious issue? If I understand the accounts, Unilever's corresponding figure is 22% - not too different.

I dipped my toe into Halma last year. I looked at it's 11 year record before doing so. A share bought on the 12/6/2007 and held until 11/6/2018 would have delivered an XIRR of 20.59%. Dividends are low of course, but a near seven-fold increase in share price is rather impressive. The TR beats the pants off most of my holdings.

No guarantees of course, buying yesterday's success story can be the same as buying tomorrow's failure!

They may or may not be doing some fancy footwork with the accounts, but if so, they are certainly managing to keep the balls in the air for a long time.

As is my habit these days, I checked out shorting befor buying. 0.5%.

[TheMotorcycleBoy]

I dipped my toe into Halma last year. I looked at it's 11 year record before doing so. A share bought on the 12/6/2007 and held until 11/6/2018 would have delivered an XIRR of 20.59%. Dividends are low of course, but a near seven-fold increase in share price is rather impressive. The TR beats the pants off most of my holdings.

No guarantees of course, buying yesterday's success story can be the same as buying tomorrow's failure!

They may or may not be doing some fancy footwork with the accounts, but if so, they are certainly managing to keep the balls in the air for a long time.

As is my habit these days, I checked out shorting befor buying. 0.5%.

Hi 77ss

Thanks for replying. Yes Halma did at first seem to be worth a punt. They certainly have many revenue earning product areas in their mix. I was actually quite impressed upon discovering the fact that their CFO (Kevin Thompson) has been in that position since 1997, especially after reading about firms like Dominos (DOM) getting through 3 FDs in a decade or so.

But when I looked at the numbers at first, I was circumspect; but then I determined that I was being too harsh, and that other firms may do similar things, and I should do a comparison first, before ruling them out. So, I decided to compare Halma to two other FTSE100 firms. Unfortunately I did not include ULVR in my comparision, instead I choose Next and Croda. If you refer to here:

viewtopic.php?p=191536#p191536

you will see that the numbers imply that Halma is quite pricey for a company with mediocre ROCE. Of course some analysts may state that the low ROC or ROE is low merely because such much goodwill / intangibles are on their books, and that if you removed them the firm would end up with a lot higher returns on it's capital.

The "problem" with removing the goodwill/intangibles is that certainly for 2018, and several of the prior years, when you do this, you will notice that the company is then in negative equity. Now, being new to private investing and company analysis, I don't know exactly how big a problem this is. I would certainly like to know, and I know from earlier posts by other lemon fools that some are alarmed by this in company accounts.

thanks again,
Matt

[77ss]

I dipped my toe into Halma last year. I looked at it's 11 year record before doing so. A share bought on the 12/6/2007 and held until 11/6/2018 would have delivered an XIRR of 20.59%. Dividends are low of course, but a near seven-fold increase in share price is rather impressive. The TR beats the pants off most of my holdings.

No guarantees of course, buying yesterday's success story can be the same as buying tomorrow's failure!

They may or may not be doing some fancy footwork with the accounts, but if so, they are certainly managing to keep the balls in the air for a long time.

As is my habit these days, I checked out shorting befor buying. 0.5%.

Hi 77ss

Thanks for replying. Yes Halma did at first seem to be worth a punt. They certainly have many revenue earning product areas in their mix. I was actually quite impressed upon discovering the fact that their CFO (Kevin Thompson) has been in that position since 1997, especially after reading about firms like Dominos (DOM) getting through 3 FDs in a decade or so.

But when I looked at the numbers at first, I was circumspect; but then I determined that I was being too harsh, and that other firms may do similar things, and I should do a comparison first, before ruling them out. So, I decided to compare Halma to two other FTSE100 firms. Unfortunately I did not include ULVR in my comparision, instead I choose Next and Croda. If you refer to here:

viewtopic.php?p=191536#p191536

you will see that the numbers imply that Halma is quite pricey for a company with mediocre ROCE. Of course some analysts may state that the low ROC or ROE is low merely because such much goodwill / intangibles are on their books, and that if you removed them the firm would end up with a lot higher returns on it's capital.

The "problem" with removing the goodwill/intangibles is that certainly for 2018, and several of the prior years, when you do this, you will notice that the company is then in negative equity. Now, being new to private investing and company analysis, I don't know exactly how big a problem this is. I would certainly like to know, and I know from earlier posts by other lemon fools that some are alarmed by this in company accounts.

thanks again,
Matt

I don't know much about Domino's or Croda - never held them, or even given them more than a passing thought. I chose Unilever for
a comparison as :

a) I hold it
b) It has done well
c) It is a company that I would expect to have a fair slice of intangibles (brands, acquisitions...)

ULVRs goodwill and intangibles combined are almost twice its equity (28,401m to 14,387m). I'm not sure that I understand Halma's acounts (or ULVR's for that matter), but it looks as though their goodwill and intangibles combined are a mere 5% above its equity (866.724m to 828.397m).

I think it is right to keep an eye on such potentially evanescent factors such as goodwill and intangibles. But what is the likelihood of much of it suddenly disappearing? A major acquisition (often referred to as transformational!) going wrong could (and has, with other companies) become a real problem. A string of minor bolt-ons is, I feel, different - spreading the risk if you will.

I'm not trying to make a case for Halma, just using Unilever to give a bit of perspective on 'negative equity'. Perhaps Bunzl would be a better comparator as it seems to grow in the same way as Halma, but I haven't looked at this company (yet).

[TheMotorcycleBoy]

I don't know much about Domino's or Croda - never held them, or even given them more than a passing thought. I chose Unilever for
a comparison as :

a) I hold it
b) It has done well
c) It is a company that I would expect to have a fair slice of intangibles (brands, acquisitions...)

ULVRs goodwill and intangibles combined are almost twice its equity (28,401m to 14,387m). I'm not sure that I understand Halma's acounts (or ULVR's for that matter), but it looks as though their goodwill and intangibles combined are a mere 5% above its equity (866.724m to 828.397m).

I think it is right to keep an eye on such potentially evanescent factors such as goodwill and intangibles. But what is the likelihood of much of it suddenly disappearing? A major acquisition (often referred to as transformational!) going wrong could (and has, with other companies) become a real problem. A string of minor bolt-ons is, I feel, different - spreading the risk if you will.

I'm not trying to make a case for Halma, just using Unilever to give a bit of perspective on 'negative equity'. Perhaps Bunzl would be a better comparator as it seems to grow in the same way as Halma, but I haven't looked at this company (yet).

Thanks 77ss,

Yes using ULVR (or/and maybe DGE) would perhaps have been a better comparison. The reason I used Croda CRDA and Next NXT in my numbers comparison was because I have recently updated my generic analysis spreadsheet, and those 2 firms were the recent FTSE 100 constituents which I'd run through the sheet.

As you perhaps know I'm new to this game, and I'm still learning, and hence I'm not 100% sure of the full implications of company's having a Negative Tangible Book Value. But I'd sure love to know!......

thanks again,
Matt

[Alaric]

But I'd sure love to know!......

Perhaps try the same analysis on a known failure such as Carillion .

A hazard for investors is asset failure. That's where a Company seemingly given a clean bill of health a few months earlier suddenly collapses. It's not just goodwill and intangibles that can become worthless but they invariably seem prime candidates for write-offs. The Company goes into administration, there's nothing of value to sell in a restructure, so shareholders get nothing.

[SalvorHardin]

you will see that the numbers imply that Halma is quite pricey for a company with mediocre ROCE. Of course some analysts may state that the low ROC or ROE is low merely because such much goodwill / intangibles are on their books, and that if you removed them the firm would end up with a lot higher returns on it's capital.

Ignorinig goodwill is one of the tricks that makes a company look much better than it is. I remember some years ago where a major bank trumpeted the "fact" that its return on capital was much higher than its competitors. What it had done was to ignore the goodwill that it had created with several large acquisitions, reducing its capital base and thus increasing its ROCE.

The company had gone one step further in its creative accounting by not amortizing its goodwill, thus removing a negative effect on the profit and loss account. And of course this company loved to talk about EBITDA in the hope that investors would prefer to focus on the much larger EBITDA per share rather than the smaller EPS.

The problem is that whilst goodwill and intangibles are more nebulous than tangible assets, in the modern economy they represent an increasingly large proportion of the typical company's asset base. A company which has created a phenomenal brand (e.g. Coca-Cola) is unable to put any of it on its balance sheet. But if the company were to sell this intellectual property and then repurchase it this would create a huge amount of goodwill.

Then again the value of many tangible assets on the balance sheet can bear little or no resemblance to the market value of the assets, particularly if the company is using America's GAAP (Generally Accepted Accounting Principles) rules which prefer to make value = cost minus accumulated depreciation.

[TheMotorcycleBoy]

Ignorinig goodwill is one of the tricks that makes a company look much better than it is. I remember some years ago where a major bank trumpeted the "fact" that its return on capital was much higher than its competitors. What it had done was to ignore the goodwill that it had created with several large acquisitions, reducing its capital base and thus increasing its ROCE.

Yes, it was pretty clear that was the reason why Halma's ROCE is less than the other two firms I compared here
viewtopic.php?p=191536#p191536
is due to the large footprint made by intangibles and goodwill.

The company had gone one step further in its creative accounting by not amortizing its goodwill, thus removing a negative effect on the profit and loss account. And of course this company loved to talk about EBITDA in the hope that investors would prefer to focus on the much larger EBITDA per share rather than the smaller EPS.

Yes. I did note that whilst HLMA do deduct the A&D from the profit, it gets readded of course in the cash flow statement. So it pushes up cash flows.

The other fishy thing I noticed with HLMA is lots of internal development costs are not expensed but are included in Capex (and then amortised). I'm at work now, so I can't access the exact figures. But IIRC this is detailed in various notes sections of their ARs. I noticed this feature right through from 2014-2018.

Whilst I appreciate that a R&D heavy tech co. will do this (e.g. a chip manufacturer) i.e. will invest lots in R&D, and capitalise as intangibles, but then it will (hopefully) use this a big revenue spinner. But with HLMA we are talking more about a manufacturer that is building a portfolio of acquistions and harvesting their product lines are we not? Rather than a traditional R&D firm.....but that's in my naive newbie opinion.

Matt

PS sorry for slightly fast reply, first day back at work

[TheMotorcycleBoy]

But I'd sure love to know!......

Perhaps try the same analysis on a known failure such as Carillion .

A hazard for investors is asset failure. That's where a Company seemingly given a clean bill of health a few months earlier suddenly collapses. It's not just goodwill and intangibles that can become worthless but they invariably seem prime candidates for write-offs. The Company goes into administration, there's nothing of value to sell in a restructure, so shareholders get nothing.

Hi Alaric,

I have never looked at CLLN as it had already gone pear-shaped prior to Mel and I's involvement in investing. Whilst I'm sure that the whole story with CLLN is quite a lengthy one; by and large, can we summarise that it's cause of death was "asset failure".

Also what exactly is "asset failure"? Is it when a firm needs some cash, realises it does have any in it's current assets, has no tangible fixed assets that it can sell, and it's creditors (i.e. bank) when approached then realise that the rest of the balance sheet is worthless, and they basically foreclose on the joint?

(FWIW, it was clear from my peek at HLMA that the above doesn't seem likely to happen anytime soon, I just think it's probably a bit pricey, for a lowish ROCE, and all the assets and capitalisation and A&D merrydown just materialised, after I started to dig a bit deeper into it's 2014-2018 ARs).

Matt

[simoan]

I have never looked at CLLN as it had already gone pear-shaped prior to Mel and I's involvement in investing. Whilst I'm sure that the whole story with CLLN is quite a lengthy one; by and large, can we summarise that it's cause of death was "asset failure".

Also what exactly is "asset failure"? Is it when a firm needs some cash, realises it does have any in it's current assets, has no tangible fixed assets that it can sell, and it's creditors (i.e. bank) when approached then realise that the rest of the balance sheet is worthless, and they basically foreclose on the joint?
Matt

That's pretty much it but I wouldn't waste any time looking at CLLN. The warning signs were there years before it went bust:

1. Fat cat management
2. Acquisitive debt fuelled growth leading to weak balance sheet.
3. Very low margin lumpy revenue contracting business.

If you avoid all the above you will do OK investing in the long run. Everything else regarding CLLN is just noise.

All the best, Si

[Alaric]

That's pretty much it

Some other examples from the recent past

https://en.wikipedia.org/wiki/Polly_Peck
https://en.wikipedia.org/wiki/British_a ... h_Holdings
https://en.wikipedia.org/wiki/Independent_Insurance
https://www.telegraph.co.uk/finance/272 ... -City.html

and back in the pre-internet days
https://api.parliament.uk/historic-hans ... nce-co-ltd

[simoan]

Some other examples from the recent past

https://en.wikipedia.org/wiki/Polly_Peck
https://en.wikipedia.org/wiki/British_a ... h_Holdings
https://en.wikipedia.org/wiki/Independent_Insurance
https://www.telegraph.co.uk/finance/272 ... -City.html

and back in the pre-internet days
https://api.parliament.uk/historic-hans ... nce-co-ltd

I'm sorry but these cases included fraud or other criminal activity. No-one is saying that was the case with the collapse of Carillion. There's a big difference between criminality and the fatal combination of poor fiscal management, arrogance, stupidity and incompetence that ended Carillion. And all of this is well off-topic on a thread about a company as solid as Halma tbh.

All the best, Si

[TheMotorcycleBoy]

This is a shot of some data from my analysis spreadsheet on Halma. Notice how the second data row of each of the groupings pertains to "capitalised internal developments", a.k.a. costs they've decided to not include in the P&L (on the understanding that *all* these costs are constituting useful intangible assets).

Then notice the corresponding line in the second grouping, where the costs are amortised.

Without bringing out my calculator, I'd guess that the capitalisation of internal developments represents about 80% of intangible capex. Sneaky or par for the course? Whatever it is, it's jolly creative!


Matt

[TheMotorcycleBoy]

I read this book a while ago. IIRC the practice of not expensing costs but capitalising as intangible assets and later amortising them is discussed. (I also have a recollection that sometimes a discounting procedure is used so that the value amortised is reduced, or something, but don't quote on this detail. Anyway I'm definitely planning on re-reading this book, after I finish my current one).

The book (which I recommend) has plenty of case studies (yes CLLN does get a mention!! but I've forgotten a lot of the other names). In a couple of firms the above practice was executed and the book describes this in graphic and figurative detail.

Matt

[Alaric]

I read this book a while ago.

From the description, it sounds as if it discusses similar themes to the book "Accounting for Growth" by Terry Smith (now of Fundsmith) back in the 1990s.

https://www.amazon.co.uk/Accounting-Gro ... ef=sr_1_1h

[TheMotorcycleBoy]

But I'd sure love to know!......

Perhaps try the same analysis on a known failure such as Carillion .

A hazard for investors is asset failure. That's where a Company seemingly given a clean bill of health a few months earlier suddenly collapses. It's not just goodwill and intangibles that can become worthless but they invariably seem prime candidates for write-offs. The Company goes into administration, there's nothing of value to sell in a restructure, so shareholders get nothing.

I did want to start a new thread about assets, and depreciation, amortisation, impairment and write-down in the "Company Analysis" board, but seeing as several are posting here I'll write it in this thread.

Firstly am I right in saying that all of these above terms "depreciation, amortisation, impairment and write-down", are referring to just different manifestations of the same thing, and that is, a reduction in the value of an asset on the balance sheet?

Secondly am I right in saying that all of these "reductions in value of a thing in the assets column" must be exactly replicated by a matching loss in the P&L statement?

By way of some examples:

1. A firm has £5m in outstanding receivables (e.g. more than 6 months old) in 2017. In EoY 2018 it has received £1m of the money expected, of the £4m remaining the company decides that about £1m of this will never be recovered, and so it "writes it off". Does that mean (if it is obeying the rules) that the company must account for the £1m loss as an impairment cost/charge and use this to reduce it's gross profit?

2. A firm has spent £5m developing an internal system which it argues it can use over the next 5 years. It then conceals the upfront cost from the P&L account, instead listing the £5m as an additional amount in it's intangible assets which it then reduces the value of by a £1m each year. Again, for compliance, must a corresponding exactly £1m be reduced from profits each of the next 5 years?

Although it may seem that I'm stating the "obvious" (well to some), but what puzzles is the time value of money right here. Since in inflationary environments the nominal value of an asset may increase with time.......e.g. in a country with 7% inflation $5m of machine could cost $10m to replace in 10 years time. However, regards the depreciation of the original ($5m) purchase is the future replacement cost (e.g. $10m) ignored in the way that the original assets depreciation is accounted? (I'm assume it is.....)

thanks Matt