£HEAD - General Sequential Company Discussion From Sept 21

This is an article following Gus 1065's lead to try to get some specific company discussion going .

Headlam is a UK focused floor covering company that has been built up over the last 20 years by multiple acquisitions of small, regional carpet & flooring companies to create a national player in a £3bn pa market (at distributor level pricing), where it claims to have x6 the sales of its nearest competitor with (my calculation a +/- 20% share.

Using its scale, its acts as an intermediary between global floor cover manufacturers and especially the traditionally small, independent carpet/floor fitters who often want to buy room size pieces. The former outsource the complex distribution of bulky carpet, the latter have no need to hold inventory which needs to be very wide and buy pre-cut as needed. Ave/piece order is only about £150.

Historically, (at least 2010 onwards) it was very conservative. All goodwill at acquisition was written off; acquired companies kept their own name and sales force; annual reports gave real detail about how costs built up and operational decisions made eg bought X vans and cash generation was used to keep debt very low before being paid out in quite generous dividends – around 25p/share or 4+% yield in 2016-19. Share price reflected this being very unspectacular and tightly held.

Even prior to Covid it had started to be shaken up a bit as with its national footprint largely done, it moved from buying cheap, distressed Mom’n’Pops to higher quality firms that strategically widened its sphere of operations ie beyond carpets. (Unfortunately, its biggest example was Domus, a specialist floor covering company for bigger projects in London in 2018). It also had long held plans to create a massive new freehold owned distribution centre in Ipswich finally underway to consolidate depots in SE.

A focus on cost control meant it entered Covid with key projects like updating its distribution network and more focus on digital. (Frankly, it was conservative to the point of being a bit behind the time!)

Covid hit it quite hard (April 20) but very briefly since everyone being home engendered a residential boom as soon as tradespeople were able to move about again. Residential is roughly 2/3 of sales with commercial 1/3. By H1 2021, overall Sales are now about back to 2019 levels (Residential +4%, Commercial -12%).

Management also changed in 2019 and have used Covid to make significant operational changes behind the scenes. The distribution efficiency project and Ipswich warehouse were finalised and rolled out and projects to make the trade counters much more effective profit centres in their own right started, with retail-like displays, better curated sku selection, own brands and new layouts. Covid also accelerated digitalisation and systems upgrades on purchasing, finance and customer interactions (invoicing, stock availability, order status etc). My impression is that all of was a bit behind the times because its scale advantage had enabled it to coast. All of these projects involved recruiting new managers and new skill sets (and losing some – some senior mgrs. Now at Likewise (LON:LIKE) and around 10% of sales headcount from memory.

Long term, perhaps the most exciting change has been the effort to map the whole (UK) market and identify areas of over and under-trading. It revealed and quantified huge market shares in the small end (not stated but implication well over 20%) and under-trading in the 1bn+ sales to national retailers (where its share is <10%) and via the web.

For the first time it got serious about national retailers, hiring a heavy hitter and investing in a new national accounts sales team. At the other end, the sales force was significantly reduced in number but freed from an X calls/day structure to be focused on allocating time more freely to develop total revenue in their area as they wished ie call on new/bigger opportunities more, less on small operations. Whilst this has some risk, as ex-FMCG sales&marketing manager this makes a lot of sense to me. War stories are given of national chains unaware of, never mind dealing with, Headlam since approaches were previously made by low level salespeople under different trading names vs top-to-top approaches under Headlam brand which is how big business with chains is done. In the next 3 years, I believe this could add up to £100mn in revenue – the organic growth the share price has been missing.

It’s scale should also help it pass on any costs from rising freight costs – it says it achieved rises of between 3-14% in H1. Indeed, I expect relative competitive advantage since smaller suppliers will gace bigger cost increases and probably some inventory shortages that Headlam say they have avoided.

All this is explained in an excellent July 21 Capital Day presentation deck here. (For SCVR followers, Head’s latest H1 21 results were also looked at Roland Head (2/9/21) and Paul Scott (6/9/2021). Both were positive, Paul especially – although neither held at the time. H1 results slidedeck is presented here here.

Financially, the company remains strong with low debt. It did not dilute equity as a result of Covid, although it did suspend dividends. These are now re-starting with a 5.6p payout planned for Nov ’21 and analysts expect another 10p expected as Final (if 1/3 to 2/3 ratio is re-established). There is also a lot of freehold and real assets on the balance sheet.

Personally, as a result of the lower cost base (better distribution, depot consolidation Ipswich, digitalisation of purchasing) and higher UK sales (new focus of big accounts, better handling of small to medium sized and non traditional channel customers), I expect the business by 2023 to be much better than before – ie aligned with the Mgt target of Op margin increasing from historic 5% level to 7.5%. If this can be applied to higher sales this is a double improvement. Personally, I expect op profit to go from +/- £40Mn pre-covid to well over £50Mn by end of 2023.

There is always competition and clearly business is going online but I feel the business model focused on scale and service remains intact. New competitors will no doubt emerge (eg LIKE) but a bit like DFS in sofas, they now have a (famous last words!) unassailable position – provided they don’t screw up! Unlike DFS, their balance sheet is bullet proof (net cash and feeholds) and PE has not had a go. Paul Scott points out this might make them a takeover target for PE to repeat this game or for someone wanting a national distribution network fast!

BTW - I'm happy that interim dividends are resuming with 5.6p planned in Nov., conservatively back to roughly 2/3rds of 2019 level for this year but looking good for later. In short, very happy to continue to hold as one of my 'getting rich slowly' shares.

Since this is intended to be the start of place to share company specific analysis and insights, I won’t put on my target price. However, it is now (usually) my biggest personal long term holding and I am expecting to hold for at least a couple of years, all else being equal. However, current analyst forecasts are for an EPS of 31p for y/e Dec 2022. At 480p, that gives a multiple of 13. However, for a market leader which was steadily over 500p pre-Covid and is now a better business I think and with a strong balance sheet, 600p ie +25% plus divis with relatively low risk IMHO is not unreasonable in 18months time. I clearly expect a bit higher at some point – but who knows.

I’d welcome any constructive builds or substantive corrections.