Growth on the back of acquisitions

Seven years ago Hudaco faced the harsh reality that its key markets, mining and manufacturing, were in fundamental decline. The value-added distributor’s only hope was diversification, a challenge it has met with remarkable success.

“Our growth over the past seven years has essentially been driven by acquisitions,” says CEO Graham Dunford.

It is growth that has resulted in Hudaco lifting annual revenue from R2.5bn seven years ago to what is set to be more than R6.5bn in its current year to November. Operating profit over the past seven years doubled from R300m to R605m.

In Hudaco’s latest half-year to May, acquisitions again played a key role. Excluding acquisitions, revenue would have been down 2.3% at R2.41bn while operating profit would have been 0.8% down at R240m. Acquisitions left revenue up 6.5% at R2.67bn and operating profit up 9.4% at R269m.

Since 2010 Hudaco has closed 21 acquisitions, with four in the past financial year and three in the latest half-year to May. Most have been of companies with a strong slant towards consumer products in sectors including automotive after-parts, alternative power, professional communications, security and power tools.

The deals have reduced the group’s reliance on mining and manufacturing. In 2010 mining accounted for 24% of group sales and manufacturing 26%. These levels have since almost halved, with mining contributing 13% of sales and manufacturing 16% in 2016.

The overall contribution from engineering consumable products fell from 67% in 2010 to just over 50% in 2016.

Consumer products upped their contribution to group operating profit from 37% in 2010 to 62% in the half-year to May.

Hudaco has proved itself adept at rapidly integrating acquired companies, something Dunford attributes to its success in retaining their senior management.

The group has also never bet the farm on any single acquisition. Targeted companies have come with price tags ranging from about R30m to R170m, with payments subject to a three-year earn-out clause.

There has been one exception: automotive spares distributor Partquip, which it bought in 2014 for R531m.

It has proved a great buy for Hudaco, lifting its revenue almost 12% in 2016 to R1.05bn, or 19% of the group total.

“Partquip is doing very well,” says Dunford. “In tough times people keep their cars longer and, when they are out of warranty, [they] shift from dealerships to cheaper private garages for their servicing.”

Hudaco’s acquisition drive is showing no signs of slacking. “We have a good pipeline of bolt-on acquisitions,” says Dunford. “None is a big company. There is just no big stuff around.”

When the acquisitions come, deals are struck at about a 5 p:e to 6 p:e valuation, notes Dunford.

While the focus of acquisi- tions is on consumer-type companies, Dunford stresses that expansion of its engineering consumables division remains important. Reflecting this is one of the group’s latest acquisitions: the Dished End Company, acquired in May for a maximum of R79m based on a three-year earn-out.

“Dished End produces steel end caps for pressure vessels up to 5.5 m in diameter,” says Dunford. “It is a perfect fit for our Bosworth business, which fabricates steel into conveyor pulleys.”

Hudaco has the financial capacity to continue adding a steady stream of modest-size acquisitions. The company’s balance sheet is moderately geared, with net debt of R973m at 44% of equity at the end of May. Importantly, it is a strong cash generator.

In Hudaco’s past financial year it generated cash of R394m after tax and dividend payments, more than enough to cover the costs of R168m for acquisitions and R30m net for property, plant and equipment.

In the current economic environment Hudaco is not set to shoot the performance lights out, but the company should continue to produce steady headline earnings growth of about 6%/year. On a forward p:e of about 10 and dividend yield of almost 4.5%, Hudaco is a share to accumulate on price weakness.