It is important to examine Samuel Heath (LSE:HSM) with an income metric better than conventional profits after tax. Normal earnings fail to properly consider the annual cash outflows which end up being spent on more fixed assets and on working capital items (inventory and receivables in particular) just to support the current strategic market position, and therefore turnover and profits. I’ll use Warren Buffett's “owner earnings” approach.
The idea behind owner earnings
With owner earnings we are trying to obtain the earnings that, in future, would be left for shareholders after the managers’ use of the cash generated to pay for items of expenditure to maintain the strength of the economic franchise (e.g. additional capital items, additional working capital, marketing spend, R&D and staff training) and to maintain unit volume and to invest in all value-generating projects available.
Depending on circumstances, the owner earnings figure may be the same for every future year or on a steadily rising (or falling) trend.
Naturally, owner earnings are impossible to obtain with any degree of precision because many of the input numbers are merely educated guesses about the future. Despite this imprecision it remains an important method for thinking through valuations.
Using the past to guess the future
Owner earnings analysis is about future cash available for shareholders to take out of the business. But the only evidence we have available is past data. We start with that, and then use qualitative analysis to judge whether to simply project forward the past pattern or modify the previous trend for future orientated thinking.
In the following we use what the company actually invested in new working capital items and in new fixed capital items, and what they spent on marketing, R&D and staff training etc. already deducted from the P&L.
What the analysis really requires is the amount necessary to maintain the quality of the economic franchise, unit volume and invest in value generating projects. To start with we make the bold assumption that what was spent by the managers was also the necessary amount.
When we move to forward-looking analysis to value the firm we need to make another bold assumption on the real amount needed to invest in new WC, fixed capital items, etc., in the future. The historical analysis helps us make that judgment.
“Owner earnings” in the past
£ooos YEAR 2015 2016 2017 2018 2019 2020
Profit after interest and tax deduction 394 769 1,013 980 968 1,069
Add back non-cash items such as depreciation, goodwill and other amortisation 418 369 329 423 375 421
Totals to: Amount available for distribution to shareholders before considering the need to spend on fixed capital items to maintain the company’s economic franchise, unit volume and invest in value generating projects. 812 1,138 1,342 1,403 1,343 1,487
Deduct fixed capital expenditure other than property. And deduct cash invested in working capital. (The figures shown are actual expenditures and are therefore a rough proxy for the ‘needed’ expenditures to maintain franchise, etc.) -604 -282 -804 -313 +111 -585
Owner earnings 208 856 538 1,090 1,454 902Average owner earning over the last six years is £841,000. Will the future be like the past? Now, more than ever, we are uncertain, but we can think in terms of reasonable scenarios.
Scenario 1: Recession and recovery
Owner earnings fall to zero for two years. All yea………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Samuel Heath (LSE:HSM) is a Birmingham metalworker turning lumps of brass into bathroom fittings and door handles - and charging high prices for top quality. For two hundred years has been dominated by the Heath family. Even today 79% of the shares are “not in public hands”, with most of those owned by various family members.
Shares owned, in ooo’s Percentage of equity
Samuel B Heath (Chairman) 494 19.5%
C A Heath 379 14.9%
G S Heath 379 14.9%
S A Perkins (nee Heath) 273 10.8%It has to be said, minority shareholders are at the mercy of the Heath family. My experience of holding shares in family-dominated companies is that they generally behave in a fair manner - after all, many of the minority holders are current employees, ex-colleagues or friends.
Regarding this firm, I have not come across any indication of prejudice towards minorities. Board pay is very high for £5m market capitalisation company at around £0.9m, but the bulk of that goes to professional managers rather than family.
Directors have been reasonable in paying out around one-third of earnings as dividends at 12.375p per share (current share price £2m). I imagine both family and non-family shareholders are keen on a regular dividend flow and so pressure directors to pay up. But, while the current crisis is still with us, shareholders will accept a suspension of payments.
A general point about investing in family firms is the tendency to focus on the medium and long term. Thus, there tends to be greater attention paid to reputation and preservation of a brand to be proud of. There is also a propensity toward conservative financing, so the firm can survive downturns.
In addition, family companies lean toward making greater effort to hold onto good people at all levels in the organisation – they often form strong bonds and sense of mutual dependence. There are valuable implicit personal contracts in abundance in the form of looking out for each other, being flexible, helping in a common endeavour. This camaraderie and solidarity could be a source of strength in the Covid-19 emergency.
2020 2019 2018 2017 2016 2015
Number of staff 141 141 145 141 139 130
Employment costs (including directors), £m 6.03 5.72 5.78 5.37 5.07 4.68
Average cost per head £42,766 £40,560 £39,855 £38,063 £36,475 £36,000This is not a company that changes very much from year to year or even decade to decade – just a steady rise of turnover, sending good from the same 150,000 sqft factory producing much the same products it was decades ago. While turnover grew 25% from £11.1m in 2015 to £13.9m in 2020 employee numbers rose 8% and employee costs 21%.
Samuel B Heath, 82, Chairman,
Fifth generation to oversee the firm. Joined the company in 1956, appointed to the board in 1962. Managing Director from 1963 to 1998. “He was involved in all aspects of the business and especially sales, in both home and international markets giving him a deep knowledge of the company its markets and customers. He brings a depth of financial understanding to the business, he has also led the development of a successful brand awareness campaign through advertising campaigns in the UK and other major markets.” (website). Owns 19.5% of company’s shares.
David J Pick, 62, MD until 31 December 2020
Joined the company in 1978 as an assistant production manager. Later moved into sales posts initially in the UK and then overseas. Became Sales Manager then Deputy MD with responsibility in new product development and marketing. Appointed to the board in 1995 and MD since 1998. Owns a mere 5,783 shares.
Martyn P Whieldon, 48, Deputy MD, but taking Managing Director role December 2020
Joined the company in 1995 as a sales representative in Europe. Fluent in German and French. Managed sales in both the export and home territories and has travelled widely, promoting the company's products to customers and at numerous trade shows to dealers and specifiers alike. Appointed to the board in 2010 as Sales Director, he was appointed Deputy Managing Director in F
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amuel Heath (LSE:HSM) is a very old Birmingham manufacturer of brass bathroom hardware (taps, etc) and door handles. It makes those pricier items you see selling through posh bathroom showrooms, etc. It listed on the stock market way back, in 1890. Since then it has not grown very much, sticking to one factory in the UK, and now having a market capitalisation of only £5m (shares at £2). Its market value rose to £12.5m (shares at £5) in 2005 and again in 2017, but Brexit fear has been disruptive and Covid-19 closed its customers’ showrooms, so turnover is down considerably on its normal rate of around £14m.
It might be the case that this year’s fall in revenue and plunge into losses is a one-off and Samuel Heath will, in a year or two, go back to making around £1m after-tax profit for shareholders and sending them dividend cheques totalling £314,000 per year (around a 6% dividend yield on the current share price).
On the other hand, the recession might be so severe for premium-priced shower fitments and faucets that Samuel Heath struggles to survive. Thus, we need to assess both its potential if it does revert to the past average of earnings and dividends and its financial distress likelihood.
Earnings and dividends
March yearend Revenue, £m Profit after tax £000’s Earnings per share, p Dividends per share, p
2020 13.9 1,069 42.2p 5.5
2019 13.9 968 38.3 12.375
2018 14.4 980 38.7 12.375
2017 13.1 1.013 40.0 12.375
2016 12.6 769
2015 11.1 394 15.5 11.75
2014 11.0 443 17.5 11.75
2013 10.1 555 21.9 11.75
2012 9.8 515 20.3 11.75
2011 9.8 232 9.2 11.75(Throughout, the number of shares in issue has been constant at 2.53m).
Over the decade turnover has grown at a stately average of 4% per year. And now, in a Covid-19 afflicted year, it’ll be lucky to achieve the revenue number it did in 2011.
Average earnings per share over the ten years is 27.4p.
The cyclically adjusted price earnings ratio is 200p/27.4p = 7.3, which is half that of the UK market.
In the last few years the directors have been downbeat………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Prof. Glen Arnold
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