Description

All figures in Euro's

DESCRIPTION:

Faiveley Transport SA is a France-based company that supplies parts and components for the rail industry. The company has a strong market position in an attractive industry with strong margins, good ROEs and high EPS growth. Faiveley has a solid balance sheet and a growing order book. The company is controlled by family shareholders and management has a meaningful stake in the company. The company hit a bump in the road in FY2012 primarily due to project execution issues in China. You can purchase the Company today at roughly 10x normalised earnings: a substantial discount to both intrinsic value and the valuation of its peers.

ACTIVITY:

Faiveley Transport has 4 activities: brakes & safety, access & information, energy & comfort and services.

Brakes & Safety: In this area the company designs, installs and maintains braking systems for trains. This segment currently contributes 20% to sales. The company estimates the market size at €2.3bln and its market share at 11.5%.

Access & Information: This division, 17% of sales, makes train doors, steps to enter the train and windows. Faiveley has an 18% market share of a €1.39bln market.

Energy & Comfort: In this division, 23% of sales, Faiveley produces pantographs and switches, air conditioning systems, heaters and driver master controllers. They have a 28% market share of a €0.87bln market.

Services: This division provides solutions to improve maintenance at railway companies. It provides solutions to simplify work for operators while reducing maintenance costs by increasing reliability.

The segment is the company’s largest in terms of sales, and contributed 40% to 1H2012 sales. This segment has stable performance and recurring revenue due to a large base of over 500 clients and the company’s ability to increase the number of services it offers these clients.

Faiveley has a global business with 57% of sales in Europe, 26% in Asia Pacific and 17% in North & South America.

The company sells its products to leading train manufacturing companies like Bombardier Group, Alstom Transport, Siemens Mobility and Westinghouse Rail Systems. During FY2012 Faiveley realised 28.9% of sales with the 3 largest train manufacturers (Alstom, Bombardier and Siemens) and 50% with its 10 largest clients (including SNCF, Indian Railways, Stadler, Trenitalia, Ansaldo, Datung and CRC)

Faiveley has only 2 global competitors in an otherwise fragmented market. Knorr-Bremse, a German privately owned company, does €2bln sales in rail and claims a 50% market share for brake systems, 30% for entrance systems and 25% for airco systems. Westinghouse Air Brake Technologies (WAB) does $1.9bln in sales with >50% market share for brake systems in the US and a smaller market share for its other products. WAB does 80% of sales in the US and 63% in freight. For Faiveley these numbers are 17% and 5%.

The industry players have remained the same for many years. A track record of reliability and safety is an important barrier to entry. As the development times are long it means you need reliable, profitable suppliers to make sure the train gets developed and that parts are available for a long time. Also, in a lot of cases the clients are governmental or regional authorities which only invite established players to tender.

Together with rational pricing from all competitors, this has resulted in stable and high profit margins and attractive returns on capital for the whole industry. For the period 2006-2012 Faiveley Transport achieved an average EBIT margin of 12,7% and ROE of 18,5%. These figures indicate that the company has a competitive advantage. We see no reason why this moat cannot be sustained going forward.  

MANAGEMENT

Thierry Barrel assumed the chairman and CEO role in 2011 when his predecessor retired. He joined the company in 2009 but his track record is very short. In FY 2012 his total compensation was €948,000 of which €537,000 was variable linked to targets in terms of EBITDA and cash flow generation. The Faiveley family controls 53% of the company and has 2 family members on the board.

Last year the company acquired Graham-White, a global leader in designing and manufacturing of compressed air drying technologies and brakes in the US for $118M or 21x earnings. Not cheap, however acquisitions have been part of a successful strategy to grow sales and earnings. 

Average dividend pay-out ratio is 14% and shares have only been bought back to grant employees shares or to use treasury shares as payment for acquisitions. 

The company has an excellent track record in terms of creating shareholder value through margin improvement, earnings growth and returns on capital.

VALUATION

At the current share price of €47.80 we pay 14x last years earnings (FY2012) and 8.8x 2011 earnings. Assuming conservative sales growth of 10% in FY2013 (1H2013 sales +21%) we pay just under 10x earnings at historical average Net Income margin of 7.1%. 

Historical average FCF margin is 8% due to excellent management of working capital. I have assumed no further working capital savings and use a 7.1% margin in our valuation.

Valuation is cheap for this high quality business and low relative to peers:

Faiveley:P/E 14, EV/Sales 1.04 and EV/EBITDA 8.6 (on normalised earnings these numbers are respectively 10, 1.04 and 8) 

WAB:P/E 18, EV/Sales 2 and EV/EBITDA 12.6

Delachaux:French rail component manufacturer taken private in 2011 at 1.5X sales and EV/EBITDA 9.8

GROWTH

I see upside from both sales growth and margin improvement:

- Over the period 2006-12 sales grew at 8% p.a. and EPS at 15% (10% and 31% respectively before 2012 decline)

- 1H2013 Sales are up 21% and EPS 28%.

- UNIFE/Roland Berger expects the market for Rolling Stock Services to grow with 3.2% p.a. until 2017 supported by strong urbanisation, the need for sustainable means of transport (environment, congestion etc.), renewal of the fleet and increase in volume of trade.

- Further consolidation driven by Knorr-Bremse, Faiveley and WAB in a fragmented competitive environment.

- The order book is close to a historical high and grew at 10.2% p.a. since 2007/8.

- In FY 2012 EBIT declined with €33M and the margin fell from a record 13.9% to 10.4%. Of this decline, €27M was due to project execution issues in the platform screen door unit in China. Management claims this was an isolated event: wrong assessment of risks and costs, local project management issues and weak local management. To ensure that this event has a non-recurring impact management has taken the following actions: significant margin revision on these projects, provision for losses, reorganisation and change of local team and radical restructuring. 

SUMMARY  

I believe that 10x normalised earnings is too cheap for a company with Faiveley's track record in terms of value creation, strong market position in a defensive industry, a sustainable competitive advantage and growth potential. The company has a strong balance sheet with Net Debt/EBITDA 2.

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