Diploma (LSE: DPLM) has released strong results for the year to 30 September. The technical products and services supplier has recorded 15% sales growth, with 4% of that coming from positive currency translation. As such, Brexit could prove to be a good thing for the company if sterling continues to weaken.
Diploma’s sales rise was driven largely by acquisitions. They contributed 8% of the 15% top line growth, with Diploma’s underlying business performance pushing its revenue 3% higher. Adjusted operating margins remained broadly in line with the previous year at 17.2% and helped to push Diploma’s adjusted profit before tax 9% higher.
More impressive, though, was the 46% rise in free cash flow. While reduced working capital and the sale of assets contributed £10.9m in total, Diploma’s free cash flow of £59m shows that it is becoming a stronger and more appealing business. Furthermore, Diploma’s balance sheet has a net cash position of £10.6m, which shows that it is well-placed to increase debt levels in order to fund more acquisitions.
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Due to Diploma’s strong year, it was able to raise dividends by 10% to 20p per share. This puts it on a yield of around 2.4%. While this may seem rather low in comparison to other FTSE 350 stocks, Diploma’s dividend is covered 2.1 times by profit. This shows that it can afford to raise dividends at a faster pace than what is an already rapidly growing bottom line. As such, its income prospects are very bright.
Looking ahead, Diploma is forecast to grow its earnings by 10% in the new financial year. Although it trades on a price-to-earnings growth (PEG) ratio of 1.9, Diploma’s consistent profit growth makes it appealing on a risk/reward basis. In the last five years it has grown its earnings in each year and this shows that as well as having a bright growth outlook, Diploma is a relatively reliable performer, too.
Of course, it’s not the only support services company with long term appeal. Sector peer Electrocomponents (LSE: ECM) is forecast to grow its bottom line by 40% in the current year, and by a further 11% next year. This puts it on a PEG ratio of only 1.4, which indicates that it offers greater capital gain prospects than Diploma.
Despite Electrocomponents having a slightly higher yield than Diploma at 2.5%, its dividend coverage ratio of 1.5 indicates that there is less scope to raise dividends at a faster pace than profit over the medium term. In addition, Diploma has a better track record of growth than Electrocomponents. The latter has posted two years of profit declines and so is a riskier buy at the present time.
Alongside Diploma’s dividend growth potential and its fair valuation, this means that it holds greater promise based on the risk/reward ratio than Electrocomponents. And should sterling weaken further in the coming months, both stocks could see their financial performance improve yet further.
