Hill & Smith Hldgs Income portfolio candidate

Engaged in the manufacture and supply of infrastructure products and galvanizing services.  I do not have a holding in this company (epic code: HILS).

Market/Index	Full/FTSE SmallCap	Industry	Metals & Mining
Sales	£440.7m	Earnings	£26.3m
Market Cap	£343.1m	Share Price	442p
Norm. EPS	35.4p	Historic P/E	12.5
Est. 2013 growth	14.2%	Prospective P/E	10.9
Est. 2014 growth	6.24%	Prospective P/E	10.3
Historic Yield	3.39%	Rolling 1yr Yield	3.7%
Dividend cover	2.24	PBV	2.11
ROE 5 yr Ave.	17.0%	Operating Margin	8.9%
5 yr BV + Div return	16.4%	5 yr FCF return on BV	19.5%

HILS is one of the income portfolio candidates and is a leading niche manufacturer and supplier of infrastructure products and galvanizing supplies.  They operate three divisions - Infrastructure Products - Utilities, Infrastructure Products - Roads and Galvanizing Services.  They supply products such as pipe supports for the power and liquid natural gas markets; plastic drainage pipes; industrial flooring; security fencing; permanent and temporary road safety barriers; bridge parapets; gantries; temporary car parks and zinc and other coatings for a wide range of products.  The sales within each division during 2012 is detailed in the chart below:

Click on chart to enlarge

HILS has grown sales over the past 5 years at a CAGR of 6% pa which, considering the pull back on infrastructure expenditure over that period in the UK and Europe, is a creditable achievement.  Normalised EPS has grown by 8% pa over that period and they achieved a 5 year average ROE of 17%.  Owners' earnings have grown at a compound 16.4% pa over the past 5 years and is backed up by good free cash flow showing a 19.5% return pa on the 5 year opening book value.

HILS is a committed dividend payer with an average growth in the pay-out of 11.5% pa over the past 5 years, in fact their record of increasing dividends goes back 10 Years, delivering a CAGR of 12.8% pa. as can be seen from the chart below:

Click on chart to enlarge

Dividends are well covered by earnings and free cash flow 2.2 and 2.0 times respectively.  Gearing is a manageable 53% and interest is covered 9.8 times, with Debt at 1.55 times EBITDA (the company has set a target range of 1.5-2.0 times).

The company does have two UK defined benefit pension schemes, one closed to new entrants and future service accruals.  The net unfunded liability on these schemes was £13.8m at 31 December 2012.

The company has a target operating margin (excluding exceptional items) of 10% for its business units and the total Group achieved 10% in 2012, although this was only achieved by an excellent performance for their Galvanizing Services of 20.9%.  This margin may be diluted by acquisitions, but all businesses are expected to have a plan to achieve this 10% target.  they also have a Return on Capital (ROC) target of 20% and last year achieved 15%, they state that there is an increased focus to improving ROC by effective management of working capital.

They have set themselves targets to increase their geographical diversification and reduce dependency on UK Government spend.  Back in 2010 24% of their turnover originated from the UK Government, last year it was down to 11% and is expected to remain at around this level despite the expected increase in infrastructure spend on UK roads.  Their stated strategy is to increase exposure to emerging markets and the chart below details sales by territory:

Click on chart to enlarge

Expectation are for EPS of 40.4p this year and 42.9p next with dividends to grow by about 6% in both years.  They are followed by 4 analysts with their own broker Investec showing the lowest forecasts of 39.99p EPS for this year and 42.17p next year.

I would not ascribe an economic moat to this business, but it is clear from their reasonably high ROE and the Galvanizing Services division's high margins, that they operate in a specialist niche area with good "know how".  Their recent IMS on 15 May states that they have had a slow start to the year, but still expect to meet market estimates.  A company with a recent good track record, that is worthy of further investigation as a potential small component within in an income portfolio.  They announce their interims for the period to 30 June 2013 on 6 August.