Kendrion — Energised by electrification

In January 2020, Kendrion acquired industrial brakes specialist INTORQ and total revenues are now evenly spread over automotive and industrial applications. With this acquisition it also expanded its activities in China to more than 10% of its revenues. Kendrion is well positioned in its chosen niche segments, as its actuators are crucial in the interface between electricity and movement. Over the past three years, the company received order nominations in automotive for a total of €900m, of which 60% represents technologies that are not related to combustion engines. With a relatively high R&D spending of 6–7% of revenues, Kendrion is continuously developing new applications such as sound systems for electric cars, battery cooling systems and sensor cleaning systems.

Having fallen to a low of €8 per share in Q220, Kendrion’s share price benefited from the v-shape recovery in stock markets and has now bounced back to pre-COVID-19 levels. The anticipated recovery in automotive and continued good underlying demand in its key industrial segments, such as robotics and wind power, should be positive catalysts for Kendrion’s share price and help narrow the valuation gap with peers. Kendrion is currently valued at an 11% discount to peers on 2022e EV/EBITDA, which in part could be a result of lower profitability and a misperception that the company is predominantly a supplier to the traditional automotive sector. We value Kendrion at around €28 per share based on the average of historical multiples (€28), DCF (€29) and peer comparison (€26). Our model is purely based on organic growth although we do not rule out that the company will strike again on the M&A front over the next few years, after the relatively large acquisition of INTORQ in early 2020.

Kendrion has faced two years of declining organic revenue growth due to the slowdown in automotive and the coronavirus pandemic. As of 2021, we expect improving results, driven by the fading effect of the pandemic and positive trends towards electrification in both automotive and industry pushing high underlying demand. For FY21–23 our estimates currently assume a revenue CAGR of 9%, an EBITDA CAGR of 16% and an EPS CAGR of 33%.

With a net debt level of €103m, net debt/EBITDA was 2.3 in 2020 while the equity ratio was 47%. The company’s balance sheet offers ample room for the financing of organic revenue growth with free cash flow estimated to increase to more than €26m in 2023. The funds available for acquisitions are building up again, although in the past the company has also used equity financing.

With an exposure to the automotive and other industrial segments, Kendrion is dependent on the economic cycles in these segments.

We see the following triggers to Kendrion’s investment case and our forecasts: a faster than anticipated increase in the penetration of electric vehicles; a higher government push to lower CO2 emissions faster; higher operating leverage than anticipated; and a faster expansion in China.

The downside risks include: a longer drag from the pandemic on the overall economic environment and investment climate; a prolonged shortage of materials; increased competition in the actuator segment; and the emergence of alternative products in the different market segments.

Kendrion focuses on the development, production and marketing of high-quality electromagnetic systems and components for industrial and automotive applications. An actuator is a mechanical device that converts (electric) energy into force or motion. Its products are used in systems such as lifts, door-locking, robots, medical equipment, wind turbines and advanced actuators for electrical and hybrid vehicles in applications such as sensor cleaning, battery cooling and acoustic alerting. Through organic growth and acquisitions, Kendrion has developed into a global player in electromagnetic systems. In 2020, the company realised revenues of €396m with 2,456 employees.

In January 2020, Kendrion acquired industrial brakes specialist INTORQ and total revenues are now evenly spread over automotive and industrial applications. Looking at profitability, Industrial traditionally realises higher margins than Automotive and this difference is amplified by the pandemic, as can be seen in Exhibit 3 with Industrial representing 65% of EBITDA in FY20. Automotive realised €206m in revenues in FY20 and represented 52% of total. This division is focused on drive systems, fluid control and smart actuation technologies and offers solutions for passenger cars (two-thirds of Automotive) and commercial vehicles (one-third of Automotive). Industrial realised €190m in revenues in FY20, represented 48% of total. This division can be split in Industrial Brakes (55%) and Industrial Actuators & Controls (45%). In 2020, the acquisition of INTORQ significantly strengthened Kendrion’s position in industrial brakes. With annual revenues of around €54m, INTORQ added 13% to Kendrion’s revenues in 2020 and around 35% to the Industrial division (see section ‘Active M&A strategy’ on page 6-7 for more information on INTORQ).

Kendrion’s products are used in a wide range of applications, in both the Automotive and Industrial segments, which are shown in Exhibit 4.

The largest part of Kendrion’s revenues still comes from Germany (39% of revenues), where the roots of the company’s electromagnetic systems lie. In recent years, Kendrion has focused on growing its business outside Germany and now it generates 30% of revenues in the rest of Europe, 15% in the Americas and 16% in Asia (see Exhibit 5).

Kendrion serves a wide range of customers all over the world, the top customers in each segment are listed in the Exhibit below. In 2020, three customers represented more than 5% of total revenues, being Volkswagen and Bilstein within Automotive and Siemens within Industrial. Within Automotive, the top 15 customers represent three-quarters of divisional revenues, within Industrial Brakes half and within Industrial Actuators and Controls one-third.

Within Automotive, the contracts are typically running for around seven years, which is the lifetime of a car model. Volumes are relatively large and production is highly automated. The ramp-up of new orders can result in a lumpy development in revenues. Within Industrial, contracts tend to be shorter and Kendrion has a broad roster of clients with relatively smaller volumes when compared to automotive. Production has been increasingly automated when sufficient volumes allow.

Kendrion’s competitive advantages can be described as follows:

At its capital markets day (CMD) in September 2020, Kendrion presented its three growth areas.

At its CMD in September 2020, Kendrion set its financial targets for the period to 2025, thereby also considering the (anticipated) effect of the pandemic on its results.

The organic revenue growth target is 5% or more on average per annum, with 2019 as the starting point including pro forma revenues for INTORQ, thus the basis is €467m.

For 2025, management is targeting an EBITDA margin of at least 15% compared to the 11% reported in 2019.According to management, the anticipated improvement of at least 400bp should be driven by operating leverage (300bp) with the remaining 100bp expected to come from operating excellence within Automotive and synergies between industrial brakes and industrial actuators and controls. As Industrial is already at a margin of >15%, the improvement in the overall margin has to come from Automotive, which reported a margin of 7.5% in 2020. We believe that there is further upside in the Industrial margin towards 16–17%, while Automotive is potentially capable of achieving close to 15% by 2025.

Assuming that the company achieves its targets, this should result in revenues of at least €625m in 2025 and EBITDA of €94m. We prefer to be somewhat more cautious at the moment given the economic uncertainty and assume revenues of €590m and EBITDA of €86m (see pages 12–13 for our discussion on forecasts).

Kendrion is targeting a ROIC of >25% versus the reported 10.8% in 2020, which was down 90bp from 2019. When calculating invested capital Kendrion excludes acquisition-related intangibles, as these distort the trend in returns in the years of an acquisition, while returns on organic investments are normally higher than returns on acquired assets. We prefer to also look at the ROIC including all acquisition-related intangible assets (see Exhibit 8).

The company maintained its dividend policy to distribute 35–50% of normalised net profit, which is based on the condition that the equity ratio is at least 35%. Over the last few years, the payout ratio has been around 50%, except for 2019 when the company passed the dividend payment because of the pandemic.

Although the focus currently seems on organic growth, Kendrion may look for acquisitions from time to time as it has been the consolidator in its market segments over the past 20 years. The table below gives an overview of the acquisitions Kendrion has made in the field of electromagnetic systems since 1997.

The latest acquisition, the industrial brakes specialist INTORQ, was announced in November 2019 and finalised in early 2020. INTORQ manufactures spring-applied brakes, electromagnetic brakes and clutches for electrical drive technologies. The company was on Kendrion's short-list for a long time and the timing of the acquisition had to do with the age of the owners. INTORQ has contributed significantly to Kendrion's position in industrial brakes, adding 13% to total revenues and 35% to the Industrial division. Profitability was good and comparable to Kendrion's margin in Industrial with an EBITDA margin of 13.5% in the last financial year. The acquisition is a good strategic fit for the following reasons: 1) adding position in spring applied brake technology which is complementary to Kendrion's leading position in permanent magnet brakes; 2) adding new market segments and customers for industrial brakes; 3) adding to Kendrion's position in China; 4) has better margins compared to automotive; and 5) reducing the dependency on automotive. Kendrion paid an EV of around €80m for INTORQ which implies an EV/EBITDA multiple of 10.4x for FY18/19 (financial year to April) and 8.0x when including cost synergies.

Kendrion’s global sustainability programme is part of its overall strategic plan. The company increasingly provides information about its sustainability targets and is making good progress in lowering energy consumption and emissions. Also. many of Kendrion’s products contribute to reducing the environmental impact of the vehicles and systems in which they are used, for example by energy efficiency, fuel efficiency and lowering weight. Sustainable sourcing is also part of the strategy with sourcing only from approved suppliers and regular implementation audits. The reduction in energy usage and emissions will be achieved by streamlining processes in the company’s production plants and offices. For example, the new facility in China, which will be operational in the first half of 2022, will have photovoltaic panels on the roof, which should potentially generate 1.10MWh per annum, which is up to 60% of the internal energy requirement.

Kendrion’s management board consists of a CEO and CFO. Mr Joep van Beurden has been the company’s CEO since December 2015. In his first three years he led the company’s strategy of Simplify, Focus and Grow, which resulted in less plants, less management layers and better margins. Before 2015, Joep van Beurden was CEO of UK-listed CSR for about eight years and CEO of NexWave for about three years. Before that he had roles at Royal Dutch, Philips, Canesta and McKinsey.

Mr Jeroen Hemmen was appointed CFO in July 2019. He joined Kendrion in 2005 and occupied several financial roles such as group treasurer, group controller, finance director industrials and finance director automotive. Before 2005, Jeroen Hemmen held financial planning and treasury roles at Rabobank and AVEBE.

Kendrion has been listed on the Amsterdam Stock Exchange since 2001. Currently there are 14.9m shares outstanding and this amount has gradually increased over the past few years. In 2017, Kendrion started a share buyback programme to mitigate the impact of stock dividend and share-based payments to management. In 2019 Kendrion issued 10% new equity for the financing of the INTORQ acquisition, adding 1.4m shares. Almost 51% of the shares are in the hands of seven shareholders, listed in the Exhibit below, leaving a free float of 49%.

Public information about the electromagnetic systems market is scarce. According to Market Research Future, the global actuators market is expected to grow at a CAGR of around 5.2% during the period 2017–2025, which is broadly in line with Kendrion’s growth target.

Kendrion entered the electromagnetic systems market in 1997 through the acquisition of Binder Magnete and through organic growth and acquisitions it has developed into a global player in the chosen market niches for electromagnetics. The electromagnetic systems market has its origin in Germany, hence most of the competitors are from this region. The market for actuators is very fragmented with mainly family-owned businesses. The Exhibit below shows a list of European players within this market segment, with their revenues at pre-covid level as 2020 results are not available yet.

Kendrion is well positioned to benefit from trends such as electrification and industrial automation. Several drivers for growth are saving fuel, lowering weight and improving comfort and safety.

Kendrion’s expectation of realising 5% organic revenue growth on average over the period 2019–2025 is based on strong underlying demand in many of its chosen market segments. Below we describe the expected growth for the different market segments.

The automotive market was weaker in 2019 and the pandemic worsened the situation in 2020. Based on information from IHS Markit, total car volumes globally declined 5.5% in 2019 and 16% in 2020 (c 20% declines in the United States and Europe). Kendrion reported a decline in automotive of 20% in 2020 but witnessed a strong end to the year with revenues in Q420 only down 5% y-o-y after the decline of 44% in the second quarter. IHS Markit expects a recovery in global cars sales of 14% in 2021 followed by growth of 4.5% in 2022.

Kendrion traditionally had significant exposure to the diesel segment but that has declined over the last few years. Currently, €25–30m of revenues relate to diesel engines in passenger cars and €10-15m to trucks where diesel is still stable. Due to the increasing penetration of electric cars, diesel is set to disappear over time, although the pace of decline is unpredictable. If Kendrion’s diesel turnover would disappear over the next 10–15 years, it will only have an impact on revenues of <1% per year on average. Also, this effect is included in Kendrion’s financial targets and diesel projects will be phased out and replaced by newer technologies.

With the total car market growing modesty over the next few years, the mix will obviously change in favour of electric cars. According to BloombergNEF (New Energy Finance), growth in e-cars will be 38% per annum until 2025 and 31% per annum until 2030, with the number of e-cars growing from 1.7m in 2020 to 8.5m in 2025 and 26m in 2030.

With existing but particularly with relatively new products, Kendrion is focusing on the car of the future, the fully electric and autonomous one. The in-car architecture will completely change with one central computer system managing all different functions. In the period 2018–2020, Kendrion received project nominations in automotive for a total of €900m of which 40% is related to ICE (and less than 20% to the combustion engine of passenger cars/light vehicles) and 60% is related to projects that are independent of the type of engine.

When looking at automotive, new applications are normally first implemented in high-end car models before being rolled out to all models over a period of 10–15 years.

The number of actuators in a car has significantly increased over the past few years and this trend is set to continue. Below we list a few examples of (relatively) new products:

Within Industrial Brakes, Kendrion is active in many different segments as shown in Exhibit 13.

Kendrion expects above 5% growth on average in the Industrial Brakes segment with above-average growth in the following segments, which represent around 40% of segmental revenues.

Within Industrial Actuators and Control, the focus is on profitable growth in a range of industrial segments. This division comprises four market segments:

We value Kendrion based on historical valuation, DCF and peer comparison, with the average pointing at a value per share of around €28. The company also offers a dividend payout of 50%, reflecting a current dividend yield of 2%.

On EV/EBITDA 2022e Kendrion is valued at a discount of 16% compared to its historical valuation, with this discount increasing to 28% for 2023e. As the company is expected to recover from the pandemic during 2021, its results in 2022 will most likely reflect a more normalised year with stronger revenue growth and improving margins. We estimate an EBITDA margin of 13.0% in 2022 which is higher than the company’s 10-year average of 12% and we believe that the discount to the historical valuation is unjustified. If we assume a valuation in line with its average historical EV/EBITDA multiple for 2022e the value per share would be €28.3.

Our discounted cash flow model is based on the following assumptions:

Our DCF model suggests a fair value for Kendrion of €29.0 per share. The sensitivity analyses in Exhibits 16 and 17 show the fair value outcome under different sales growth, EBITA margins and WACC scenarios.

There are no other listed companies matching the profile of Kendrion. For comparison we have selected several industrial companies and several automotive companies and used the blended average. Kendrion is valued at a discount to the peer group based on 2022e EV/EBITDA, which in part could be a result of lower profitability and a misperception that the company is predominantly a supplier to the traditional automotive sector. As it is gradually closing the margin gap to peers and is diversifying into new, faster growing segments geared towards electrification, we believe this should justify a valuation at least on par with peers. When assuming a valuation in line with peers on EV/EBITDA 2022e, the implied value per share would be €26.3.

With its exposure to the automotive and other industrial segments, the effect of the coronavirus pandemic was unavoidable and revenues and profitability came under significant pressure in FY20. Total revenues declined 4% on a reported basis to €396m including the €54m contribution from INTORQ (or a contribution of 13%). Revenues declined 17% organically with a 20% decline in Automotive and 11% decline in Industrials. Kendrion implemented cost-saving measures to mitigate the effect of the pandemic and also made use of Kurzarbeit in Germany (short-time work) which saved an estimated €8m on personnel costs. With a strong contribution from INTORQ, which realised an above-average margin, EBITDA increased by 2% to €44.6m in 2020, driving a margin increase of 70bp. Automotive reported a lower normalised EBITDA margin of 7.5% (-210bp) while margins in Industrial were strong and ended up at 15.3% (+320bp), with a margin in excess of 16% in the second half.

Kendrion is positive about its long-term growth prospects but admits uncertainty in the short term. Underlying demand is strong, but a prolonged pandemic and the current shortage of components might affect the short-term performance.

For the years 2021 and 2022 we expect a recovery in earnings from the low level in 2020 which was caused by the pandemic. IHS Markit expects growth of 14% in global car sales in 2021 and according to Kendrion’s management, underlying demand in its segments remains high. We expect 9–10% revenue growth in 2021–22, driven by both divisions, followed by 7–8% in subsequent years. New projects will be ramped up and the doubling of capacity in China will also contribute to growth.

Several cost saving measures taken in 2020 will show their full benefit in 2021 and 2022. Total run rate savings of €4.4m were achieved in 2020 with €2m of savings falling in 2020 and the remaining €2.4m to fall in 2021. In 2020, Kendrion decided to close a plant in Austria and transfer production to other subsidiaries. Costs related to this closure are €2.5–3.0m which will be taken in 2021 and 2022. Annual savings are estimated at €2m with the full effect in 2022. Driven by higher revenue growth and cost savings we estimate an EBITDA margin improvement of 230bp to 13.6% in 2023.

Kendrion’s EBITDA margin target of >15% for 2025 reflects an increase of 400bp versus 20219 of which management states 300bp is expected to come from operating leverage and the remaining 100bp from further efficiency improvements.

Financial expenses are expected to gradually decline in line with the lower net debt over the years. The rax rate is expected to remain stable at around 25% which reflects Kendrion’s country mix. This results in a CAGR in our estimated EPS of 33% in 2021–23.

Free cash flow increased in 2020, partly helped by lower working capital due to higher stock turnover. Normalised working capital as a percentage of revenues was 10.4%. Strict working capital management remains high on management’s agenda and we see some further improvement over the next few years.

Capex has been below depreciation in the last two years, due to the weaker market conditions. In the period 2016–18, Kendrion made large investments in new products and increased capacity and as a result maintenance capex should not exceed depreciation like it did in those years (15–20% above depreciation). We expect maintenance capex to remain relatively stable as a percentage of revenues and to amount to €24–28m in 2021–23. Kendrion has announced a doubling of its capacity in China which should be operational in 1H22. Capex needed for this expansion is estimated at €15m, most of which will be spent in 2021. Therefore, total capex will be higher in 2021 and 2022 before returning to normal levels of maintenance capex.

Kendrion’s dividend policy is for a payout ratio of 35–50% of normalised net profit. Over the past five years, except for the 2019 dividend due to the pandemic, Kendrion has paid out around 50% of normalised net profit.

Due to improving results and relatively stable capex as a percentage of revenues, we expect the company’s free cash flow generation to strongly improve over the next few years towards more than €26m in 2023.

In August 2020, triggered by the (anticipated) impact of COVID-19, Kendrion agreed with its banks upon adjusted covenants (including IFRS 16): net debt/EBITDA of 4.7 at year-end 2020, 5.8 in Q121 declining to 3.25 in Q421 and onwards. In 2020, net debt increased from €47m to €103m, largely due to the financing of the acquisition of INTORQ. Net debt/EBITDA increased from 1.1 in 2019 to 2.3 in 2020 and was well within the covenant level of 4.7.

Intangible assets amount to €158m, or 37% of the balance sheet total, which is largely goodwill (73%) and the carrying amount of customer relationships (21%). Capitalised development costs amounted to €5m in 2020. Tangible assets of €119m include leases for an amount of €14m.

Driven by increasing cash flow generation, we expect Kendrion’s financial position to further improve over the next few years. Net debt/EBITDA is expected to further decline to 1.2 in 2023 and the equity ratio is expected to improve to 51% in 2023.

With net debt further declining, the funds available for potential acquisitions will increase again without the need for another equity issue (see Exhibit 23).