Cash and dividend roll off carpet business Headlam

Headlam's current capital expenditure cycle is now nearing completion and the final piece of the jigsaw is a £15m Ipswich distribution centre, which is due to be up and running by the end of next year or early 2018. This project was delayed due to a planning hold-up and the surge in free cash flow the brief let-up in investment caused led management to pay a 6p per share special dividend in its 2015 rather than sit on the money.

We think this could be a taste of things to come once heavy spending on the Ipswich centre finishes next year. Spending on Ipswich means Investec forecasts Headlam's free cash-flow yield will drop to 3.7 per cent in 2017 before rocketing to 8.3 per cent in 2018, more than enough to support the forecast 4.7 per cent dividend yield for that year.

And even more elucidatory is that at the end of June, Headlam had net cash of £33.9m. That was a 30 per cent increase from the same time a year earlier, even though it paid £5m to fund the aforementioned special dividend and experience a negative readjustment of working capital following some large, favourable one-off movements in 2015. The group's cash position, while impressive, does need to be seen in light of the business's high working-capital requirements, which at the half-year stage included £128m of stock and receivables (not-yet-paid invoices) of £123m.

The company's strong cash credentials also puts it in a good position to make acquisitions to further cement its growth in what is a fragmented sector. Management has a solid track record in this regard and targets businesses it can move into its own sites to eliminate duplicate costs.

The group has been able to deal with the main immediate issue thrown up by the Brexit referendum: currency. The weak pound meant buying new stock, which is mainly done in euros, became more expensive. Given 87 per cent of its revenue comes from the UK, its continental European business is not much of a counterweight. But Tony Brewer, who recently stepped down as chief executive to be replaced by finance director Steve Wilson, said the company had instigated an average 6 per cent price increase for residential floor coverings and there had been no adverse impact at the time of the half-year results announcement in late August. This move should help protect gross margins, which rose 30 basis points to 30 per cent in the half while operating margins rose 50 basis points to 4.7 per cent.

First-half UK sales of £286m were up 3.4 per cent on a like-for-like basis, excluding the benefit from an extra week's trading in the accounting period, which was ahead of the 3.2 per cent growth in the wider market estimated by consultancy AMA Research. UK sales are split 70/30 in favour of residential, but its newest business, Headlam Corporate, could mean commercial work becomes a larger contributor following a flat first half when Brexit uncertainty led to order delays. But Headlam Corporate's sales team has already visited 250 of the 500 architects in the Clerkenwell area, where its strategically located showroom is based.

Its small continental Europe business has also turned falling like-for-like sales last year into positive numbers this first half, and a recovery in the region seems to be picking up pace.