Description

High Level View

Enersys (“ENS”) is a 3.5bn TEV lead acid battery producer that services the forklift, telecom and cable markets and represents a compelling short opportunity as the stock trades at its long-term average EV/NTM EBITDA multiple of ~8x while all end markets it services are peaking out. Their core historical growth driving-business of motive power (which serves forklifts) is both at peak forklift cycle and likely to get disrupted via lithium. Additionally, there is likely to be disappointment around capex-cycle for telcos/MSOs that drive the new “growth” story in their other segment (reserve power). I see about 35% downside to consensus EBITDA estimates while at the same time expect ~1x EV/EBITDA derating to force a 11% FCF yield on fwd year numbers (as I expect markets to continue to shrink for years to come).

Company Overview

ENS is the largest manufacturer of industrial batteries. Focused on two segments: Motive power and Reserve Power. The Company almost exclusively produces Pb-acid batteries (>90% of sales) with Li only sold in scale to the A&D market. 

• Company has an enterprise value of 3.5bn/2.8bn equity value. Consensus has the company doing EBITDA of 465mm/Net Income of 270mm/FCF of 240mm. This implies stock is trading at 8x EBITDA, 11x P/E, 8% FCF yield

• Motive Power:  At 40% of revenue, the company provides batteries that power the forklift market in the US/Europe

• Reserve Power: Products used for backup power, mostly for telecom and broadband (together make up over half of the segment’s revenues)

• Despite global reach, company has over 60% of sales/70% of provides in NAM as it provides the highest margins. Really the rest of the business is just Europe. They have 10% of revenue in China but it earns no operating margin with revenue declining HSD annually. 

• Company has been a serial acquirer (28 acquisitions since 2003) and restructurer. Over the last 4 years, despite all these acquisitions/cost cut initiatives, we have seen op margins erode by 200bps over the last 4 years (ex-company flagged 1x charges).

Forklift Market - Peak Everywhere

High level Macro Data concerning- From 10,000 feet the forklift market orders (from WITS), show that Europe/US spending are 23%/27% above prior cycle peak, respectively. Moreover, per macro data provided by Kion, in 1Q’19, we saw the first deceleration of forklift orders across every major ex-China region (first time since ’09). Thus, on the surface, the macro for forklifts appears to be decelerating rapidly. 

Europe Macro is deteriorating and replacement cycle just peaked- A forklift typically lasts about 10 years before it is replaced. Additionally, replacement demand for forklifts in Europe is about 60% of current demand. The historical data back tests very reliably that if you are a fork lift today, you will need to buy a new one in 2029. What is interesting is that 10 years ago today, we were in 2009 when forklift orders in Europe went from 400k to 200k in a year. Thus, a little over half the European market for forklifts is about to drop significantly. Moreover, the best leading indicator for newbuild orders in Europe tends to be IP rates (which are lead by PMIs). Obviously, my macro crystal ball is as foggy as anyone’s but PMI+IP rates have decelerated pretty dramatically everyone in Europe (and particularly in Germany which is the largest forklift demand center). Thus, it appears newbuild orders for lifts in Europe will also struggle. The best real time info we have on newbuild orders comes from the two Euro OEMs, Kion and Jungheinrich, who collectively have said that orders for new forklifts (ex services) will be down mid-high single digits this year. In aggregate, a believe this will culminate in forklift orders in Europe about 15% below where they were in 2018 over the next couple of years. 

US Macro Strong but not where it counts for lifts- Firstly, the US market has proven to be a lot more volatile than the European market. Running the same analysis on replacement demand, assuming a 10 year average forklift life, you find that the US market will drop about 50k forklifts on falling replacement demand (about the same absolute drop as Europe). However, the US market at 250k lift orders this year is half the size of Europe, so a much larger magnitude drop. Secondarily, while many people hand their hats on the strong US economy as a sign newbuild forklift orders will be strong, I believe they are looking at the wrong thing. In NAM, over 40% of demand comes from warehouse starts. The AMZNs/WMTs of the world are driving this demand. The correlation between warehouse starts and lift orders is incredibly strong at >95% R^2. What is interesting is that in 2018, we actually saw warehouse starts drop by >10%. AMZN has indicated that they are bleeding thru excess warehouse capacity and that going forward starts should ease in the space as spare capacity+efficiency gains per warehouse take hold. This also makes sense with the second derivative of e-commerce sales starting to turn negative. Warehouse spending is the tip of the spear and so when e-commerce sales go from growing 30% P.A. to 15% P.A. that means warehouse starts can drop by 50%, causing a 50% drop in lift orders.

All in, this leads me to believe that the US is likely to see as great as a 30% drop in lift demand over the next 3 years.

Irrespective of forklift cycle, Li batteries are about the take over the space- I have been following the battery commodity space for a while and ’18 marked a very big year for Li-ion batteries. Following Avicenne data, you can see that the cost per Li-battery fell from ~175/kwh down to $125/kwh. This compares to Pb-acid batteries at between $100-$150/kwh. Thus, 2019 is a monumental year in that Li-batteries are now officially cheaper than Pb-acid. That was the single advantage Pb-acid really had on lithium. The other benefits lithium offers over Pb acid batteries include 1) 3x the battery life (3,000 charge cycles), 2) low maintenance (you don’t have to water a Li ion battery), 3) higher energy density (takes up ~50% as much space in the forklift), 4) lifts can do an entire shift with 1 Li battery charge compared to 3+ for Pb acid. Thus, it is my view that Li-ion batteries are now superior to Pb on every possible metric. What is equally interesting, tho, is that forklifts make even more sense than EVs to use Li because forklifts operate 20 hours a day vs EVs at 2-3 hours. These benefits are game changing for something as intensive as a lift. Many experts who know what they are talking about say now that Pb batteries will go the way of the dinosaur.

• CEO of Cummins- “Same thing on forklifts. If you do the calculations we do today, if we put lithium ion battery and replace that big acid tray, you can win today. Some of those trucks. Fork lifts have the right load and range.”

• Hyster-Yale (2nd largest NAM Lift OEM)- “Lead-acid batteries require infrastructure for charging, for watering, battery changing. Lithium solves almost all of these problems. It continues to be the focus for our energy power going forward.”

Moreover, several prominent battery consultants have Pb forklift demand from batteries going to zero by 2023. 

Finally, ENS’s motive power business almost exactly tracks the order cycle- One contention by ENS management is that there is a large, stable aftermarket for forklift batteries. They, however, do not breakout their aftermarket sales. What I did was adjusted their motive power revenue from 2006 onward for fx and acquisitions (company has done 28 acquisitions since 2003) and what I found was that their revenue growth every year was almost an identical image of what the orders did. In 2009, orders dropped 42% and ENS motive power revenue dropped 37%. In 2010, orders went up 32% and ENS revenue went up 31%. This cycle has continued every year thereafter. Moreover, the company confirmed on their last earnings call once again that they have no commercial lithium ion battery outside of A&D today, thus they will be a loser if lithium ion takes share. 

Putting Some Numbers to This-

Fork Lift Demand- In 2018, Euro+ US forklift demand was ~800k lifts. I believe by 2021, that number will drop to ~600k. Half of this is driven by just normal replacement demand modeling. The other half is driven by my view that Europe IP will be down about 4% from where it is today (implying about 60k less newbuild lifts…which gets you about 100k newbuild orders in Europe…about where we were in mid 2016) and my view that US warehouse starts will drop about 10% from 2018 levels. Again, this puts orders about where they were in 2016. 

• Thus, my view is that we see about a 20% drop in demand for PB batteries just based on the cycle. 

Li Impact- Secondarily, I believe Lithium ion penetration will grow rapidly. It doubled in 2018 from 1% to 2.4% of forklift battery demand. I believe by 2021, it will grow to be about 20% of the market (you replace a forklift battery once every 3 years and most rational actors will chose lithium). This will likewise represent about a 15% demand headwind to Pb batteries. 

• Thus, in aggregate, I expect Pb-acid battery demand to drop about 35% from where we were in 2018 (with disaster scenarios from lithium ion substitution very real)

Reserve Power – Telcom Stable with Cable Decaying

The 60% of ENS’s business linked to reserve power is about 70% linked to telcom/cable (each end market is about the same size to ENS). Management has gotten the sellside very bulled up on 5G spend for Telcoms and a potential upgrade cycle in cable from DOCSIS3.1 upgrades. I believe both opportunities to be either exaggerated or outright deceit. 

5G Spending is already here- If you aggregate wireless-related capital spending from the big 4 operators, you will see that capex was ~27bn in 2016/2017 and then stepped up to 31bn in 2018. My view is that step up is reflective of runrate capex for 5G spend. This view has been echoed but all the large telcos. Verizon has said recently that they can’t spend more on 5G even if they wanted to. AT&T indicated at their November 2018 analyst meeting they had already deployed 1/3 of its Firstnet requirements (they had 5 years to meet this target…implying front loaded spending). Sprint meanwhile said it was nearly 2/3 complete with the upgrade of all its cell sites in mid 2018. Therefore, I expect pretty stable telco capex going forward. 

Why is 5G going to be underwhelming?- Firstly, I think 5G just intrinsically is less interesting than prior upgrades. 1G gave voice, 2G gave text, 3G data, 4G video. As a consumer all of these were game changing to me. However, 5G just gives you even crazier peak bandwidth (20Gbps vs 1Gbps for LTE), 1mm sec latency (from 3mm in LTE), and the potential for IoT. None of this really matters to me…as a guy (or the avg consumer) whose most data intensive activity is watching NFLX on my phone (requiring 25mbps of data). Ericsson (one of the three big wireless OEMs) came out with a mobile subscription forecast that reflected a much slower adoption of 5G than 4G (hence less spend needed). Moreover, 4G and 5G employ the same core tech (OFDMA), which has enabled operators to simply retrofit legacy towers for 5G. IHS has come out with an even more bearish global hardware forecast that has peak 2022 capex >30% below prior peak capex in 2015. 

Final point here is that wireless carrier spending has aligned very well with legacy reserve power revenue from ENS (ENS just in October bought a company called Alpha to gain new exposure to the cable market…so all backtests rel to telco are logical). R^2 is about 88% so flattish capex spending in telco will very likely reflect flattish telco-related revenue for ENS. 

Cable Capex about to fall apart- As mentioned above, the recent acquisition of Alpha gave ENS exposure to cable capex spending. The sellside if very focused on 2 things 1) the fact legacy Alpha revenue grew 20% last year and 2) claim this is a 5G play. I think both things are highly misinformed. Firstly, on the historical revenue growth, CMCSA and Charter spent a bunch of money in 2017/2018 upgrading their cable infrastructure for DOCSIS3.1. All of that spending ended in 2018. You can look at both 1Q’19 earnings presentations. YoY capex as a % of revenue for CMCAS dropped from 12.3% in 1Q’18 to 9.5% in 1Q’19 with management saying YoY capex will be down 50bps. Charter was even more extraordinary with YoY capex down 700mm and the company guiding full year capex 2bn below where it was in 2018 (on a company that did 9bn of capex in 2019). Thus, in aggregate, I believe people will be shocked when Alpha revenue tracks cable spending and goes from up 20% YoY last year to down 15% YoY this year. 

Numbers on Telco/Cable- Math here is pretty straightforward. I think Telco capex will basically up LSD over the next few years while cable resets about 15% lower. That means aggregate revenue from reserve power will be down ~8% by 2021. 

Valuation

As noted above, on consensus numbers (which have the company CAGR-ing revenue 8% as far as the eye can see), the stock trades at 8.3x fwd EBITDA/7.7% FCF yield. What is more interesting is fact the forklift OEMs (Kion/Jungheinrich) have seen their multiples cut in half over 2018 while telco infrastructure OEMS (Ericsson and Nokia) have simply kept their multiples. Additionally, even if consensus numbers were right, given my perception we are late in the cycle, I would require a 11%+ FCF yield for this company just on the grounds that in 2008, its organic revenue dropped ~40% and is, thus, highly cyclical. 

My view, however, on this businesses core earnings power is much more cautious than consensus. I believe their motive power revenue will drop ~35% of the next 3 years (420mm of revenue lost), which at a 25% GM implies ~100mm drop in EBITDA from my bearish forklift view. Additionally, I believe aggregate reserve power revenue will drop ~8% (144mm of revenue lost), which is worth about 40mm to EBITDA. There are some offsets (they can trim opex by around 30mm as activity drops, etc). However, I believe EBITDA for this company drops from 4Q annualized of 400m to ~315mm by 2022. 

I value the company at 6x fwd my 2021E EBITDA of 345mm (30% below consensus), which backs into an 11% equity FCF yield and yields a $33PT or 52% downside to the stock. 

Catalyst

CY2020 consensus estimate cut

Reset in expectations in forklift market

Li battery penetration in forklift market

Better understanding of 5G impact on reserve power spending