Kendrion — Price increases largely drive revenue growth

Kendrion’s H123 results showed an improvement in organic revenue growth towards 9% y-o-y in Q2 after the reported 5% in Q1. The largest contributor to growth was higher average sales prices to mitigate the impact of input pressure (ie +6% y-o-y in Q2 after +3.5% y-o-y in Q1). More importantly, volumes were better in the quarter, +3% y-o-y in Q2 versus +1.5% yoy in Q1. Currencies had a negative impact on revenue growth of 1% y-o-y overall, resulting in total revenue growth of 8% y-o-y to €137m in Q223.

Management stated that market conditions deteriorated during H123. This was particularly felt in Industrial Brakes, which has a high exposure to Germany and China. In Germany, business activity fell to its lowest level so far this year. In Q123, economic activity in China was lower due to the sharp rise in COVID-19 infections because of the abandoning of the zero COVID-19 policy. The anticipated recovery afterwards did not occur, with only 0.8% GDP growth between Q1 and Q2. The construction of the new factory in China was finalised in May and all the existing activities were successfully transferred to this new plant, which has been fully operational since the beginning of August. The larger capacity will enable Kendrion to potentially double its local revenues towards €100m within the next three to four years.

Industrial (52% of revenues) showed higher organic revenue growth of 6% y-o-y in Q2 versus 3% yoy in Q1, which is explained by the higher increase in average sales prices in Q2. The Industrial Brakes segment was affected the most by the slower economic growth in Germany and China, and reported a modest 2% y-o-y organic revenue growth in Q2. Its products are mostly integrated in electromotors for segments such as robotics and automated warehouses and these market segments were under pressure. According to Kendrion, it did not lose any customers or market share. Industrial Actuators & Controls on the other hand experienced a strong quarter with 11% yoy organic revenue growth, with positive markets for aircraft products, electrical distribution, beverage dispensing systems, laser shutters and inductive heating systems, which more than offset the weaker textile manufacturing segment.

Automotive (48% of revenues) further recovered on the back of higher passenger car registrations. According to management, the commercial vehicle segment is stable and the electrification transition will take longer compared to cars. Revenues in Automotive rose 11% y-o-y in Q2 with organic growth of 12% (vs 8% growth in Q1). The acceleration in growth was driven by the stronger growth in the Automotive E segment (electric vehicle related), reporting 30% organic revenue growth in Q2 versus 7% in Q1. Growth was driven by existing suspension and sound systems. Automotive Core (combustion engine related) reported 7% organic growth, broadly the same level as in Q1.

The pressure on gross margin continued in Q2, as Kendrion is passing on the higher input prices to customers at no margin and the higher margin Industrial activities showed lower revenue growth in Q2 than Automotive. Gross margin declined 310bp y-o-y to 45.8% in Q2 after a decline of 260bp in Q1. We note that the comparison base in Q223 was stronger as Q222 gross margin was up 80bp despite input pressure.

Normalised EBITDA increased 2% y-o-y to €14.0m in Q222, with gross profit up 1% and opex below last year’s level (with cost savings offsetting wage inflation). The EBITDA margin was 60bp yoy lower at 10.2% after the decline of 140bp in Q1. According to Kendrion, half of the decline in EBITDA margin was caused by the effect of price increases. In Automotive, there was sustained high usage of outsourced development services. Kendrion is relatively optimistic about the development of gross margin going forward, as price increases resulted in a relatively better gross margin towards the end of Q2, although still below last year’s level. In H123, normalised group EBITDA declined 3% y-o-y with Industrial’s EBITDA margin down 140bp to 16.5%, while Automotive kept margins relatively stable at around 5%.

Free cash flow in H123 was a negative €12.5m, evenly split over the quarters. Capex was again higher than depreciation and other negative items were the settlement of the German tax audit (€2.5m combined with restructuring charges) and the seasonally negative working capital. Last year, Kendrion had buffer stocks to secure delivery of materials given the constrained supply chain but in the analyst call management commented it does not have any material buffer stocks anymore. Due to the seasonal positive free cash flow in H2 and lower capex, management expects a significant reduction in net debt by year-end. At the analyst meeting, the company stated it expects a positive free cash flow for the year, which hints at a net debt reduction of at least €12.5m in H2.

In Q2, net debt increased by €13m to €161m versus Q1, mainly due to the cash portion of the dividend payment of €7m and a negative free cash flow of €6m. Net debt/EBITDA increased by 20bp to 2.8x on an annualised basis versus Q1, which is within the covenant of below 3.25x.

Kendrion expects the lower economic activity levels to persist for the remainder of FY23. It has taken short-term cost measures, including short-term work in Germany, which according to management could deliver savings of around €1m per quarter. Kendrion is positive about its order book and in the next few quarters seven new projects in Automotive E will be ramped up in China. According to Kendrion, its pipeline for Automotive E is developing positively, particularly in suspension and smart actuation. Looking at the global market for active suspension production, IHS Markit expects a CAGR of 13% in the semi active damping segment and 15% in the air suspension market for the period 2022–28, which offers great growth opportunities for Kendrion. The order book for Industrial Actuators & Controls is also solid, with continued interest in new products such as industrial locks (for washing machines and refrigerators), inductive heating and valve products. Price increases will continue to mitigate the input pressure, but management did not provide any guidance regarding the extent of price increases. We still assume an effect of 5% yoy for H223.

On 29 August, Kendrion issued a press release communicating that it identified a cyber security incident and the company cannot rule out that the unauthorized party has obtained data from its systems. Kendrion took immediate action and contingency planning is in place to continue operations. It is currently too early to assess the potential impact of the incident.

Assuming a return to a more stable economic environment in the next few years, Kendrion remains committed to its medium-term targets for 2019–25: organic revenue growth of at least 5% on average per year, an EBITDA margin of at least 15% in 2025 (11.1% in FY22) and a return on invested capital of at least 25% in 2025 (FY22: 15.6%).

We have left our revenue forecasts unchanged for the next three years but have lowered our EBITDA margin estimates due to the sustained negative impact of input pressure. Previously, we assumed that cost savings would more than compensate for the input pressure, but so far this year that has not happened. Margin development in the second half should be better compared to the first half, as management communicated that further price increases will be implemented and at the end of Q2 the gross margin was developing positively (although still lower compared to last year).

For FY23–25, we still expect revenue growth of 6–8%, driven by the energy transition and accelerating electrification, with new projects ramping up and an anticipated further recovery in automotive. Our current estimates are below the company’s ambition for the period until 2025 and Kendrion will understandably need normal economic conditions to deliver higher growth levels.

We have lowered our FY23 EBITDA margin estimate by 80bp to 11.2% with the expectation that operating leverage will push margins up to more than 14% in 2025. We note that also for the profitability target for 2025, Kendrion will need a return to normal economic conditions to achieve its >15% EBITDA level in 2025.

We use three different valuation methods to value Kendrion: historical multiples, discounted cash flow (DCF) and peer comparison (for more details see our outlook report).

Historical valuation: based on our forecast 2023e EV/EBITDA multiple, Kendrion is trading at a discount of 27% compared to its historical valuation of 8.4x. As Kendrion’s EBITDA margin development is slower than we had anticipated and the current level is below its 10-year average, we think that a discount of 10% to its historical valuation is justified (previously the valuation was in line). This assumption gives a value per share of €20.2 (down from €21.9 per share previously).

DCF valuation: we have left our assumptions unchanged and are still using a WACC of 8.4%. On our slightly lower estimates, particularly at the margin level, our DCF now indicates a fair value per share of €23.4, versus €24.8 previously.

Peer group comparison: we have not changed our assumption that a valuation in line with Kendrion’s peers is merited based on the 2023e EV/EBITDA multiple, versus the current discount of 21%. This assumption delivers a value per share of €20.9, down from €22.3.

The unweighted average of these valuation methods points to a valuation of €21.5 per share (previously €23.0).