Diploma takes a prudent approach on inventories

Diploma (DPLM) has no shortage of admirers, a point borne out by a forward rating of 24 times forecast consensus earnings. It’s not difficult to appreciate why when you consider the technical product specialist’s consistent earnings growth (2020 aside) and expectations of margin improvement through FY 2022.

Indeed, management anticipates an operating margin at the top end of the 18-19 per cent guidance range for the full-year. Add in a 22 per cent increase in half-year adjusted earnings and the share price markdown on results day seems at odds with the statutory figures. Admittedly, management cautioned in January that it expected “underlying growth to moderate as the year progresses”, and it’s probable that expectations have been tempered by deteriorating macro effects as the year has progressed.

Diploma forked out £172mn on three acquisitions in the period, the largest of which brought R&G Fluid Power within the fold, effectively building scale within the UK Seals segment, yet net debt remains manageable at 1.2 times cash profits.

There was a double-digit increase in free cash flow during the half year, though the conversion rate declined by eight percentage points to a still respectable 64 per cent. This reflects a material increase in inventory levels as the group sought to mitigate supply chain constraints and to ensure that it could meet increased demand brought about by market share gains.

Management appears determined to build resilience into the group’s supply chains, a prudent approach even if it occasionally eats into cash flows. It expressed further confidence in its materially upgraded April guidance, but it is certainly taking a sober view of wider pressures in the global economy. Long-term buy.

Last IC view: Buy, 3,404p, 22 Nov 2021