Description

Delclima is an Italian manufacturer of commercial and industrial climate control equipment with #1 market share in European and #5 worldwide.  After spinning out of De Longhi in early 2012, DLC has faced selling pressure as a result of the economic crisis in Southern Europe as well as a recent customer dispute at the company's non-core (and loss-making) DL radiator division.  As this dispute is resolved and DLC moves to divest the radiator division, investors will once again be able to focus on the company's core Climaveneta division which has an excellent brand in high-end, energy efficient climate control. 

Adeo Dispute

In late 2012, French retailer ADEO launched a recall for DL radiators due to a defect on a very small number of DL Radiators electric towel- warmers.  While the cost of this recall is likely to be relatively small (according to DLC mgmt, 4 radiators out of 235k sold from 2007-2010 had problems and there were 0 injuries) and is covered by DL Radiators insurance, ADEO blocked payments for ALL DL radiators products (not-just the towel-warmers) leading to almost 18mln of overdue receivables at the end of Q1 13.  This non-payment led to a significant cash outflow from working capital, causing net debt to spike from 25mln to 42mln at the end of Q1 13. DLC has since recovered 3.5mln and has begun to seek legal redress to recover their cash.  Recovering the remainder of this cash will shrink DLC's EV by 10% and will remove an overhang on the stock.  Importantly, the current balance sheet already shows the negative impact from Adeo as DLC has already recovered some of the cash and should be able to recover more of these held receivables.

Radiators

DL Radiators has been an underperforming asset for Delclima, losing money on an EBITDA basis in both 2011 and 2012 (although 2012's loss was inflated by 3mln in provisions related to Adeo).  The company has been restructuring the divisions and believes is will generate positive cash flow in 18 months.  However, the company is also looking at strategic alternatives for the radiator division.  I believe selling this division for any consideration would be viewed as a material positive and would lead to a revaluation of DLC.

Climaveneta

DLC's core Climaveneta brand is highly respected globally for its expertise in energy efficiency and complex installations.  Climaveneta's strong brand reputation has been corroborated customers and competitors who have noted the company's leading technology, strong execution capabilities and respected management. As evidence of its quality, Climaveneta's products have been used in prestige projects all over the globe including the headquarters of the Chinese General Staff in Beijing, The European Parliament Building in Strasbourg, the data center for the Indian Institute of Technology, multiple BMW plants in both Europe and China, and Etihad Stadium in Manchester.  I would recommend going to the website to have a look at some of their completed projects.  Due to the radiators overhang, DLC's current share price does not adequately recognize the quality of Climaveneta.

www.climaveneta.com

Valuation

At EUR 0.73, DLC has a 110mln market cap.  At Q1 13, the company had 42mln of net debt and has since recovered 3.5mln from ADEO for a total EV of 149mln.  This EV is 4.2x TTM EBITDA of 35mln and 5.9x TTM EBIT of 25mln. 2013 FCF should be ~14mln or a 13% FCF yield.  I believe this is very inexpensive for a company of this quality.  At e1.40, DLC would be trading at ~7x EBITDA, 10x EBIT and a 6.5% FCF yield, in line with European peers.  If the company were to sell/restructure/shut down radiators, earnings would be 10% higher which could provide further upside and would be a catalyst for revaluation.

There are several other sources of upside as well.  Resolving the ADEO dispute will add 0.10 per share of value and will lift an overhang on the security.  Industry HVAC transactions have generally taken place above 10-12x EBITDA.  Based on 40mln of TTM HVAC EBITDA at 10x, DLC would be worth e2.40 per share.  Due to its underlevered balance sheet (1x EBITDA even with Adeo) and significant free cash flow generation, DLC could pay a large sustainable dividend which could act as a catalyst for the share price.  While they have not paid a dividend yet, management has seemed receptive to the idea. 

Since 2005, DLC has produced at least ~20mln of EBIT each year (2009 low of 19.6mln when revenue decline 20% y/y during financial crisis) which includes negative profitability from radiators.  At 6x this depressed EBIT, DLC would be worth e0.53 per share or less than 30% downside at current prices with improved downside protection if the company recovers some of the Adeo receivables. 

Catalyst