Description

Forbo Holding AG (“FORN SW”) is a net-cash European industrial products company currently at an earnings inflection point trading at 8.0x EBITDA, a 33% discount to its historical multiple of 11.9x EBITDA.  The company has two stable businesses that consistently convert 50% of its EBITDA into FCF.  This is because FORN SW is run by a management team with a sharp focus on maximizing profitability and shareholder returns, having returned 63% of its market cap to shareholders in the last 10 years through share repurchases and dividends.  There is 48.2% upside to an investment in FORN SW if the shares simply return to their historical multiple.  Additionally, FORN SW will see accelerated growth in the coming years as it’s a beneficiary of two durable macro drivers: environmental sustainability and factory automation.

FORN SW has two business segments – Flooring Systems and Movement Systems, both of which are leaders in their respective fields:

Flooring Systems (68% of total sales):

The Flooring Systems segment manufactures linoleum and vinyl floors primarily for commercial buildings.  FORN SW has a dominant market position globally in linoleum flooring with more than 70% global market share.  While linoleum flooring has not grown as quickly as vinyl flooring in the past due to lack of customer awareness and vinyl’s more appealing design options, it has been a stable profit center for FORN SW providing consistent free cash flow.  We expect FORN SW’s new linoleum products to gain a greater share of the flooring market as they have become much more comparable to vinyl in terms of design.  Additionally, linoleum flooring contains only natural materials, making it one of the most environmentally friendly flooring products.  Therefore, the global push to increase sustainability is giving Forbo much better opportunities to market the product, and they stand to gain the most given their market dominance.  Over the years, FORN SW has also achieved a much more balanced flooring portfolio by expanding its offering beyond linoleum to the higher growth vinyl floors, focusing only on higher margin products that are less subject to low-cost competition.  Given 80% of the company’s floors are sold to healthcare and education end markets, and 40% of sales are tied to renovation/remodel, sales have historically been less sensitive to economic cycles.

Movement Systems (32% of total sales):

FORN SW is a market leading manufacturer of specialized conveyor belts mainly used for food and beverage production and handling.  FORN SW’s conveyor belts are viewed to be the highest quality, with industry participants calling FORN SW’s belts the “Cadillac” of the industry.  Around 60% of the segment’s sales are attributable to the Transilon product line, with about 75% of its sales derived from food processing customers.  Focused on specialty conveyor belts and processing belts, Transilon is a market leading brand with over 600 designs.  For example, it has a patented fabric belt design that includes a sealed belt edge, which prevents bacteria and liquids from penetrating the belt.  This improves the safety and quality of food processing customers’ products and increases the longevity of the belt.  The remaining 40% of the segment’s sales are from several other product lines such as Transtex, Prolink, and Extremultus.  End markets served by these other brands include logistics, mail, packaging, and food & beverage.  This business has a high degree of recurring revenue as belts in busy manufacturing and production facilities routinely need to be replaced and this business continues to benefit from increased automation in logistics/warehouses and manufacturing facilities. 

As reflected in the table below, FORN SW has historically generated consistent results.  It’s worth noting that the strengthening CHF has been a headwind to FORN SW’s topline (most notably in 2015) given most of its sales are outside of Switzerland.  In constant currencies, FORN SW had a 10-year topline CAGR of 2.9%.

Shares of FORN SW are down 32.8% from the 2021 highs as the war in Ukraine caused enormous macro uncertainties.  The rapid increase in commodity prices pressured FORN SW’s margin beginning in early 2022, and the European energy crisis in late 2022 resulted in a slowdown in customer activities across Europe.  Following a rare profit warning in November 2022, the company reported 2022 EBIT of CHF 132.6 million, significantly below the prior year’s CHF 179.0 million.  However, CHF 20 million of the profit decline was one-time in nature, the majority of which was related to the company’s rapid response to the changing environment and rightsizing of its cost structure to preserve profitability.  While continuing to expect a weak economic backdrop, the company issued a net profit guidance for 2023 that’s CHF 30 million above 2022’s results, highlighting the company is back on track.

Over the past 19 years FORN SW has been led by executive chairman This Schneider, who personally owns 2.8% of the company, along with Michael Pieper, who personally owns 29.3% of the company.  Together they run the company conservatively and choose to return capital to shareholders rather than make risky investments.  In the last ten years, management has returned 75% of FORN SW’s operating cash flow and excess cash to shareholders, including the repurchase of 30% of the company’s shares.  

Aside from an expected earnings recovery and trading at a trough valuation, there is further upside from a recent CEO change.  In March 2023, the former CEO of Kardex, Jens Fankhanel, joined FORN SW to be the company’s new CEO.  Kardex is a publicly traded materials handling company we have followed for years and think highly of, and we’re delighted to see its CEO jumping ship to lead FORN SW.  Under Jens’ leadership in the past 7 years, Kardex grew topline at a 7.9% annual rate while consistently improving profit margins.  Similar to FORN SW, Kardex also prioritized shareholder return, as 63.5% of operating cash flow over the last 7 years was returned to shareholders via dividends and share repurchases.  As a result, Kardex shareholders enjoyed a 157% total return during Jen’s tenure as the company’s CEO.  Armed with a net-cash balance sheet, the new CEO will be able to withstand any further economic softness and, more importantly, focus on accelerating growth in the movement systems business as facilities worldwide continue to increase automation.

We believe FORN SW is hyper focused on improving profitability and that, when combined with low expectations, will allow FORN SW to exceed expectations in 2023.  There’s further upside when Europe comes out of its energy crisis and customer activities are no longer constrained.  In the medium term, we believe FORN SW’s linoleum business will benefit from sustainability and its Movement Systems segment will benefit from increasing automation.  Downside is limited as FORN SW is net-cash, consistently generates cash, and will likely tender for shares again in the Fall if they continue to trade at a discounted valuation.

Catalyst

Beating 2023 guidance

Continued large share repurchases