Kendrion — Coping well with challenging market conditions

Kendrion reported Q3 revenues that were clearly higher than we had expected (+15% y-o-y to €113m versus our estimate of €108m). The main difference was the much stronger growth in industrial whereas the slower growth in automotive (due to material shortages and volatile ordering) was as expected. According to management the supply chain problems are much larger compared to the problems experienced during the pandemic last year and are not limited to shortages in the semiconductor sector.

Organic revenue growth in Q321 was 14% y-o-y, with the remaining 1% from forex gains. Organic growth in the automotive division was 6% y-o-y despite the much lower number of car registrations in Europe in the quarter, resulting in 21% y-o-y organic revenue growth in 9M21, particularly driven by the strong recovery in Q221. The industrial division reported 21% y-o-y organic revenue growth in brakes and 25% y-o-y in actuators & controls in Q3, with both segments reporting higher growth rates than in H121 and both reporting organic revenue levels above the pre-pandemic levels seen in Q319.

Gross margin was 40bp y-o-y lower at 48%, mainly due to the impact of higher raw materials prices (particularly in industrial brakes). High demand volatility in automotive (due mainly to semiconductor shortages) also had a negative impact on profitability resulting in normalised EBITDA growth of 9% y-o-y to €12.4m (versus our estimate of €13.5m) compared to revenue growth of 15% y-o-y. Q3 EBITDA was more than €3m lower than in Q2; according to management 80% of this was caused by lower volumes (normal seasonal pattern but also order cancellations) and the remaining 20% was caused by inefficiencies due to volatile order patterns. Despite the difficult market conditions, Kendrion managed to limit the decline in normalised EBITDA margin in Q3 to only 60bp y-o-y to 11.0%. For the first three quarters of 2021 the EBITDA margin was still up 140bp y-o-y to 12.7%. Due to lower depreciation charges, normalised EBITA increased 30% y-o-y in Q3 (+86% in 9M21).

Non-recurring items of €0.5m included costs related to the acquisition of 3T in the Netherlands, which was announced in late September 2021. 3T is a developer, manufacturer, distributor and provider of lifecycle management services for client-specific electronics and embedded systems. It offers a strong fit with the control technology activities of Kendrion’s Industrial Actuators and Control division (around 25% of total revenues). It will also benefit the Automotive division by strengthening its software and electronics development capabilities, which are becoming increasingly important in this division. According to Kendrion, 3T has annual revenues of €12m and is highly profitable (EBITDA margin of around 20%).

Kendrion’s financial position remains strong with an equity ratio of 44% and net debt/EBITDA multiple of 2.4x, which is well below the covenant of 3.25x. Net debt increased from €113m in H121 to €141m in 9M21, largely due to the acquisition of 3T, which is consolidated as of 21 September (cash out was €23.3m and the IFRS lease liability was €1.9m). Free cash flow was a negative €3m in Q3, but this was mainly due to higher inventories (partly to secure its own production) and higher capex (partly related to the construction of the new manufacturing plant in China, scheduled to be fully operational after the summer in 2022).

Kendrion is cautiously optimistic, with the economy expanding rapidly as we emerge from the pandemic, but with high demand volatility and supply chain constraints continuing, possibly well into H122. Management does not expect the situation to get worse, but it remains difficult to predict. Within industrial brakes, the company has taken price actions to cover the higher raw material costs and it expects to feel the benefit in Q421 and Q122. Within automotive, contracts contain clauses based on which Kendrion can pass on the higher price of raw materials to its customers. All in all, management expects the gross margin to stay around 48%. Currently there is more demand than the company can meet, and this gap is larger in automotive, but short-term cancellations make it difficult to control direct staff costs, which can sometimes lead to inefficiencies.

Based on the positive long-term trends, Kendrion is confident that it will realise its financial targets for FY25: organic revenue growth of 5% or more on average per annum and an EBITDA margin of at least 15%, which compares to the 11.3% reported in FY20. If the company achieves these targets, they should result in revenues of at least €625m and EBITDA of at least €94m in 2025.

We have slightly raised our revenue estimates after the stronger than expected growth in Q3, particularly from the industrial segment, while the industrial order book looks very good according to management. We have also included the acquisition of 3T which has a positive impact on overall profitability. We now estimate group revenue growth in FY21 of 16.5% of which 15.5% is organic (our previous estimates assumed 12% growth). We have left our revenue growth estimate for automotive almost unchanged at 15.5% (was 16%) but raise our estimate for industrial to 17.5%, of which 16% is organic growth (was 12%). For 2022 and beyond, we continue to expect 6–8% organic revenue growth, driven by positive underlying trends, new projects and the doubling of the floor capacity in China.

We have lowered our EBITDA estimate for FY21 to incorporate the larger than expected effect of supply chain constraints and volatile ordering. We now expect EBITDA of €55.7m versus our previous estimate of €58.5m, which reflects a 90bp reduction in our margin estimate. However, this still assumes an 80bp y-o-y increase in margin to 12.1% for the full year, mainly driven by the reported margin recovery in the first half. For FY22 we are more cautious about the margin development in the first half due to ongoing material shortages but we expect higher margins in the second half, partly due to a favourable comparison base. The adjustment to our FY22 EBITDA estimate is far less severe compared to our adjustment for FY21 due to the contribution of an estimated €2.4m from the acquired 3T which will also have a positive impact on the overall margin. From FY23 we expect a steady margin improvement driven by the high level of revenue growth.

Kendrion has started a process of closing the manufacturing plant in Austria (planned for H222) and the first product lines are already transferred to subsidiaries in Germany and Rumania and several larger ones will follow. Restructuring charges are estimated at €1–2m with the bulk of this falling in FY22, whereas previously we anticipated half of it being charged in FY21. With gradually lower financial expenses, due to declining net debt, and a broadly stable tax rate, we expect a CAGR in our estimated EPS (before amortisation) of 41% in 2021–23e.

We value Kendrion using three different methods, namely historical multiples, discounted cash flow (DCF) and a peer comparison. Please refer to our initiation note for more details.

Kendrion’s 2022e EV/EBITDA shows a discount of 22% versus its historical multiples. When we assume a valuation in line with its historical multiples, as current profitability is in line with its historical average, this points to a value of €28.5 per share (versus €29.0 previously). For our DCF, we have not changed our assumptions, but on our adjusted estimates and higher tax rate, the fair value comes in at €27.7 per share versus €29.4 previously.

The peer group multiples have declined since our last update in August, most likely driven by the uncertainty about the magnitude of the impact of the supply chain constraints. Still assuming a valuation in line with peers on 2022e EV/EBITDA delivers a value per share of €24.7 (from €26.2).

The unweighted average of these valuation methods points to a value of €27.0 per share, down from €29.0 per share previously, but still offering ample upside potential in the share price.