Diploma continues to earn top marks

Shareholders who backed Diploma’s (DPLM) equity raise just over six months ago have been handsomely rewarded, with the specialist distribution company’s shares gaining in value by more than 30 per cent since.

There have been a few triggers for this, including its ascension into the ranks of the FTSE 100. A strong set of consensus-beating earnings provided another leg-up.

Diploma raised £235mn – partly to refinance its £76mn purchase of Tennessee Industrial Electronics (TIE), with the rest earmarked to pursue other deals, given a “strong near-term active pipeline of approximately 50 opportunities”, it said at the time. It has since spent £170mn on Distribuidora Internacional Carmen (DICSA), a Spanish distributor of hydraulic hoses, fittings and components. These two deals, combined with 10 smaller bolt-on acquisitions worth £33mn, took its annual acquisition spend to £280mn.

Chief financial officer Chris Davies said that Diploma has completed 20 bolt-on deals since 2019 at an average multiple of under five times earnings before interest and tax, and that these had earned an average return of 20 per cent within a year. Bigger deals at higher multiples typically take longer to deliver, but its return on average trading capital employed has stood at 19 per cent over the past five years, with revenue growing at a compound 20 per cent rate and adjusted operating margin averaging 18 per cent.

As mentioned in our ideas section last month, this far outweighs fellow distributors such as Bunzl (BNZL), but the company is more of a specialist, offering a higher service element. 

Whether such returns will be sustained as acquisitions get bigger is something to consider, but for now there are few signs of a slowdown. Group-wide volumes were still growing at 7 per cent at the year-end. The company expects “double-digit” revenue growth for 2024 and for its adjusted operating profit margin of 19.7 per cent to be maintained. And even after completing so many deals this year, Davies said Diploma has a “£1bn-plus pipeline” of opportunities to pursue. The March capital raise and a 36 per cent increase in free cash flow generation to £164mn provide “significant investment headroom and flexibility” to do so, he added. 

A 9 per cent post-results bounce means Diploma’s shares now trade at over 24 times Shore Capital’s forecast earnings – well above Bunzl’s 16 times but in line with quality peers Halma (HLMA) and Spirax-Sarco Engineering (SPX). Given its track record, we think this is a fair price to pay. Buy.

Last IC View: Buy, 2,902p, 12 Oct 2023