Kendrion — Industrial weaker, Automotive still in recovery

Kendrion’s Q323 results showed a rapid deterioration in several Industrial segments while Automotive still seems to be in recovery mode. Group revenues declined 6% y-o-y with an organic decline of 5% and a negative currency impact of 1%. Higher average sales prices contributed 5% yo-y to revenues, which was expected and at the same level as in Q223. In H123, the company further increased its prices to compensate for the prolonged input pressure (material cost and wage inflation), with the full effect in the second half. During the analyst call, management commented on the challenging market conditions in the quarter, which it had warned about at the Q223 results, pointing to the risk of recession, the lacklustre economy in China and the weaker German machine-building industry. Weaker market conditions in Germany and China were indeed the main reasons for the decline in revenues in Q323.

A ransomware attack in August 2023 did not have a substantial financial impact, according to the company, other than external consulting costs and a temporary increase in working capital (customers could not be invoiced for one week). Kendrion was able to resume production within one week.

After four quarters of lower gross margin, Kendrion managed to increase its gross margin in Q3 by 140bp to 48.7%, driven by the 5% higher average sales prices and its product mix. According to management, this mix is not related to the split between Industrial and Automotive but due to several activities throughout the company which have higher margins realising above-average growth. For example, subsidiary 3T in the Netherlands showed a strong performance and it clearly has higher margins as it focuses on industrial control technology rather than production.

Last year’s cost-saving measures in Automotive and this year’s reduction in discretionary operating costs compensated for continued wage inflation, resulting in flat operating expenses, after an increase of 3.3% in H123. This flat opex and the 3% lower gross profit have led to a 12% decline in EBITDA to €13.1m, or a margin decline of 70bp to 10.5%.

Normalised net profit declined by 41% yo-y to €3.6m, mainly due to higher financing costs because of the higher interest rates and net debt. This brings the 9M23 normalised net profit to €13.6m, a decline of 28%.

Net debt remained stable at around €160m compared to the end of Q223, as the free cash flow of €3m was offset by higher lease liabilities. Net debt/EBITDA slightly increased to 2.9x and although this still is within the covenant of 3.25x, the development of this ratio will be closely watched. During the analyst meeting, management said it would focus on strict cost control, working capital management and prudent investment to keep its financial position healthy. The ransomware attack had a temporary negative effect on working capital as customers could not be invoiced for one week, but payments were received in October, thereby helping Q4 cash flow (we estimate several million euros). Kendrion still expects a positive free cash flow for the full year after the decline of €9.5m in 9M23 and we estimate the net debt/EBITDA level to slightly decline to 2.7x by year-end. The company is still planning to sell its building in Austria, where last year production was transferred to two other Kendrion locations. This could bring in an estimated €2–3m cash, helping to bring down net debt further.

Kendrion’s segments showed opposite trends in Q3 with Industrial hard hit by weaker economies in Germany and China, and Automotive still in recovery mode with continued high single-digit organic revenue growth (although largely price driven).

Industrial Brakes showed a significant drop of 30% y-o-y in revenues, an impact of the weaker German and Chinese economies, particularly in the wind power and industrial automation segments. At the time of the H123 results, Kendrion had anticipated a recovery in China, but this has not occurred. The comparison base was also strong as this activity showed 28% y-o-y growth in Q322. During the analyst call, management commented that there were no major differences in growth between the months within the quarter. Kendrion had seen destocking effects during the year and management stated that this effect is now behind it. The company has kept its market share and management does not anticipate further market deterioration, so we assume the performance in Q423 should potentially be better than in Q3.

Industrial Actuators & Controls did relatively well as it has a more balanced portfolio and less exposure to China compared to Industrial Brakes. Revenues in Q3 declined 3% y-o-y but are up 3% y-o-y year-to-date. The good performance in the market segments control technology, aviation and medical was offset by weaker industrial automation.

Automotive continued its high single-digit organic revenue growth path of the past few quarters by reporting 9% y-o-y growth. The organic revenue growth in Core of close to 10% was largely driven by price increases, while the organic growth in Automotive E of 8% was largely volume driven. With new projects ramping up in Automotive E this segment should show accelerating growth from Q423. In previous analyst calls, management has indicated that these projects have combined annualised revenues of around €20m or over 30% compared to reported FY22 segment revenues.

The lacklustre Chinese economy affected Kendrion’s performance year-to-date. China is one of Kendrion’s strategic growth areas and the company’s new plant has been operational since July 2023, offering room for revenue growth of around €50m to €100m in the next three to four years. As previously communicated, the company is ramping up seven new projects in Automotive E in China and management expects a modest contribution from these projects to revenues in Q423 and a substantial contribution in FY24, which should lead to growth in the overall Automotive division.

Kendrion expects the challenging market conditions to continue in Q423 and into H124. Based on public information and the company’s own visibility, the fourth quarter will be difficult. Kendrion is also cautious about the first half of next year (although visibility does not reach that far) and management is preparing for the challenging market conditions to continue.

We have lowered our estimates for FY23–25, mainly in the Industrial division. Group revenue growth is lowered by 5–8% and EBITDA by 12–18%. Our FY23 revenue estimate is lowered by 5% and now assumes 1% y-o-y growth after the 2% y-o-y reported growth in 9M23. For Automotive we estimate 8% growth and for Industrial a decline of 5%.

Based on 5% growth in Automotive Core and 20% in Automotive E, we estimate organic revenue growth in Automotive at >9% in both FY24 and FY25. For Industrial we now expect no revenue growth in FY24, with the second half compensating for an anticipated decline in the first half (also due to comparison base), followed by a recovery in FY25. These divisional forecasts boil down to 5% revenue growth at group level in FY24, followed by 9% in FY25.

Our new estimates for FY23–25 reflect a CAGR in revenues of 5%, in EBITDA of 10% and in normalised EPS of 16%.

The company did not reiterate its medium-term targets, which are an average organic revenue growth of at least 5% in the FY19–25 period and an EBITDA margin of 15% by 2025. During the analyst meeting, management stated that it stood by its comments made at the H123 results that these targets are still within reach, but the company will need more favourable economic conditions than those of the past three years. Management remains positive about the company’s long-term outlook, driven by electrification and green energy trends.

For the valuation of Kendrion, we look at three different valuation methods: historical multiples, DCF and peer comparison (see our outlook note for more details).

Historical valuation: based on our forecast 2023e EV/EBITDA multiple, Kendrion is trading at a discount of 27% compared to its historical valuation of 8.2x (last nine years). As Kendrion’s FY23e EBITDA margin of 10.4% is currently below its nine-year average of 11.6%, we think that a discount of 10% to its historical valuation is justified. This assumption gives a value per share of €16.0 (down from €20.2 per share previously).

DCF valuation: we have made one change to our model assumptions by raising the market equity risk premium from 5% to 6% to reflect the current uncertain economic environment and the low visibility in both of the company’s divisions. This increases the WACC from 8.4% to 9.4% and, combined with our lower estimates, this reduces the DCF fair value to €16.1 (€23.4 previously).

Peer group comparison: we have not changed our assumption that a valuation in line with its peers is merited based on the 2023e EV/EBITDA multiple, versus the current discount of 13%. As peer multiples have come down in recent months, this assumption delivers a value per share of €14.3, down from €20.9.

The unweighted average of these valuation methods points to a valuation of €15.5 per share (previously €21.5).