Morning Note: Market news and an update from distributor Diploma.
Market News
US equity markets drifted lower – S&P 500 (-0.4%), Nasdaq (-0.2%) – on Fed comments, with the 10-year Treasury yield rising to 4.06%. The dollar rose to a one-month high and gold slipped to $2,024 an ounce. Boeing slumped 8% to a two-month low after the Federal Aviation Administration extended the grounding of its 737 MAX 9 airplanes indefinitely. Chip design software company Synopsys has agreed to buy engineering simulation software business Ansys in a $35bn stock and cash transaction.
This morning in Asia, equity markets also sold off led by Hong Kong: Hang Seng (-4.0%); Nikkei 225 (-0.4%); Shanghai Composite (-2.1%). The losses came after official figures showed while China reached its 2023 economic goal, the country’s housing slump has worsened, and domestic demand remained listless.
UK inflation unexpectedly accelerated to 4.0% in December vs. 3.8% expected, tempering hopes for a rate cut. Sterling edged up to $1.2670 and €1.1648. The FTSE 100 is currently trading 1.4% lower at 7,454.
Brent slipped to $77.50 a barrel as crude output in the Permian Basin continues to break records and is forecast to increase for an eighth month — the longest streak since 2021 — to reach 5.97m barrels a day in February, according to the EIA.
The EU is moving ahead with plans to start a new naval operation in the Middle East to protect commercial shipping. The global LNG tanker fleets appear to have stopped using the Red Sea and Suez Canal, ship-tracking data showed. Some insurers are starting to avoid covering UK and US ships in the Red Sea, Marsh said. Japan’s three largest shipping firms became the latest to halt transits through the area. Volvo is the latest manufacturer to halt production because of shipping disruption in the Red Sea. It has paused output at its factory in Belgium.
Source: Bloomberg
Company News
Diploma has this morning released a brief trading update for the three months to 31 December 2023, the first quarter of its financial year to end-September 2024. The group has made a strong start to the year and reiterated its full-year guidance. In response, the shares are down 1% in early trading against a weak overall market backdrop.
Diploma operates a decentralised collection of distribution businesses which supply specialised industrial and healthcare products and services to a wide range of niche end markets, in which service, rather than price is the key reason business is won and retained. The focus is on the supply of low cost, but essential products, such as a seal for a hydraulic cylinder. Most of the revenue is generated from consumable products, usually funded by the customers’ operating budgets rather than their capital budgets, providing a recurring revenue base. By supplying essential solutions, not just products, Diploma has built strong long-term relationships with its customers and suppliers, which support attractive and sustainable margins (in the high teens) and consistently strong cash flow.
The strategy is to build high-quality scalable businesses that deliver sustainable organic growth. Acquisitions are an integral part of the strategy, with a disciplined focus on acquiring value-added businesses in fast growing niches, with great management teams, to accelerate organic growth and generate attractive returns on investment.
During the latest quarter, reported revenue growth grew 10%, including an 8% contribution from acquisitions and a 4% foreign exchange headwind. Organic revenue growth was 6%, just ahead of the group’s 5% financial model. Growth was broad-based and mainly volume led.
In Controls, the group supplies specialised wiring, cable, connectors, fasteners, and control devices used in a range of technically demanding applications. The division enjoyed continued ‘strong’ growth in the quarter.
In Seals, the group supplies a range of seals, gaskets, filters, cylinders, components, and kits used in heavy mobile machinery and specialised industrial equipment. During the period, the unit performed ‘robustly’, delivering moderate organic growth.
The Life Sciences business supplies a range of consumables, instrumentation, and related services to the Healthcare and Environmental industries. Momentum in the business remains positive, with ‘strong’ growth generated in the quarter.
The company generated a ‘strong operating margin’ in line with expectations. As expected, there was no update on the group’s financial position, although we expect free cash flow generation to have remained strong. At the last balance sheet date (30 September 2023), financial gearing was 0.9x net debt to EBITDA, well below the 2.0x target. Diploma has a progressive dividend policy with a target cover of two times adjusted EPS, which has now been achieved. In the last financial year, the payout was raised by 5%.
Acquisitions continue to be an integral part of the group’s growth strategy – during the quarter, three bolt-on acquisitions were made for a total consideration of £9.5m at average multiples of around 4x EBIT. The group remains disciplined in its approach to acquisitions and has a healthy near-term pipeline.
Whilst the company remains mindful of the uncertain economic outlook, a resilient business model, coupled with the strong start to the year, mean management remains confident in its unchanged full-year guidance:
- organic revenue growth of 5%.
- recent acquisitions will add 6% to reported revenue growth.
- operating margin in line with last year at 19.7%.
- free cash flow conversion of 90%
Source: Bloomberg