Industrial components-to-healthcare products distributor Diploma (DPLM) falls 10.6% to 679.34p on a profit warning caused by unfavourable foreign exchange rates. The £770 million cap joins the growing list of companies seeing a loss of earnings once they translate sales from foreign regions into sterling, the reporting currency.
Diploma warns that pre-tax profit for the year to September 2014 is likely to be at a similar level to last year which was £54.3 million. Stockbroker Numis had expected pre-tax profit this year to hit £58.5 million. It downgraded estimates in January because of foreign exchange headwinds, reducing its numbers to £57 million. Clearly the FX problems have continued, causing yet another downgrade today.
The issue for investors to consider is the strength of underlying trading, which shows a 7% gain in the first-half period. That's a decent performance, so share price weakness may be considered by some investors to be a buying opportunity. Yet that would be assuming a reversal of current FX pressures, which is hard to predict.
Diploma earns three quarters of its revenues outside the UK. It has a big presence in the US, Australia, Canada and Europe. The business comments: 'In addition to the impact on a translation basis, the group's Healthcare businesses will be increasingly impacted on a transactional basis by the substantial depreciation of the Canadian and Australian dollar against the US Dollar and the Euro, which are the currencies in which their products are mostly purchased. Gross margins in these businesses will soften during the second half of the year as our currency hedging contracts start to expire, though local management are working with suppliers and customers to mitigate the impact.'
We've been long-term fans of Diploma given its high levels of cash generation, attractive dividend growth track record and consistently high return on invested capital. We last wrote on the stock earlier this month in our dividend cover story, flagging the risks with currencies near-term.
We said: 'A large exposure to the US means there’s foreign exchange headwinds as its accounts are reported in sterling, yet it remains hugely attractive to long-term investors who can look past short-term pains. The business is very diversified which means that if one of its sectors is not doing too well, earnings should be protected by other parts. That’s evident by sustained earnings growth during the 2008-09 global recession.'
Stockbroker N+1 Singer reiterates its 'buy' rating and 800p target price ahead of talking to the company, but says it expects to downgrade earnings to £55 million due to currency impact.
Analyst Andy Brown says: 'Diploma is a quality outfit having delivered a combination of organic and acquisitive growth over a number of years. It has good product and geographic balance which gives it greater defensive qualities than many of its peers. While its North American Seals business has seen cyclical recovery, we expect the group to continue to grow through its Healthcare and Controls operations. It continues to invest which will benefit future margins. With its consistent delivery record, strong balance sheet and proven management we maintain a positive stance and 800p target price but the share price may struggle short term.'