Howden Africa HWN.SJ
April 04, 2016 - 8:33am EST by
2016 2017
Price: 2,500.00 EPS 327.94 0
Shares Out. (in M): 66 P/E 7.6 0
Market Cap (in $M): 112 P/FCF 16 0
Net Debt (in $M): 0 EBIT 261 0
TEV (in $M): 65 TEV/EBIT 0 0

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  • South Africa
  • Industrial Goods


Howden Africa is a high quality, industrial business with first-rate ROICs and a low valuation (more on this
later, but it trades on ~7.6x ’15 earnings). It primarily builds and sells parts for industrial fans and heat
exchangers and generates almost all of its revenue (95%) from South Africa. In 2014, 60% of revenues came
from the power industry, 16% from mining, 15% industrial, and the balance of 9% from several other
The business is comprised of two segments, with the largest, Fan & Heat Exchangers, accounting for over
80% of revenues and more than 90% of operating profit. This segment builds, sells parts for and maintains
industrial fans, compressors, and heat exchangers. It consistently generates ~25% EBIT margins and returns
on equity greater than 30%. The other segment, Environmental Control, is not the same quality but still
generates segment level ROEs in excess of 20%. Environmental control grew over 50% last year and will
likely drive growth in the future given the structural tailwinds behind increased environmental regulation,
particularly in power generation.
Howden Africa is 55% owned by Colfax. Colfax acquired Charter International in 2012, which owned
Howden Global. Howden Global is now a subsidiary of Colfax and has three global divisions, based on
product type, except for Howden Africa which is a standalone regional player. Colfax is largely known but
for those who don’t know it, it is controlled by the Rales brothers who were the architects behind Danaher
which has compounded book value at 18% annualized over the past 20 years. Danaher was created from a
real estate company but grew into a business that focused on platforms where the Rales brothers could
acquire additional businesses within the respective platforms. They focused on manufacturing businesses that
could be steadily improved with an emphasis on a close integration with the customer. The key operating
tool that Danaher has used is a lean manufacturing system called Danaher Business Systems, which has
driven incremental improvements and increased operating margins on acquired businesses. Colfax has filled
its management team ranks with ex-Danaher execs and is implementing a similar system, cleverly named
Colfax Business Systems (CBS). Howden Africa is also using this system to consistently improve its
The team is led by CEO Thomas Barwald, who joined Howden Africa in 1990. Although his tenure does
provide stability to the business, the key advantage of the business lies in the installed base so it isn’t
dependent upon a superstar manager. Unfortunately, management receives stock based comp in Colfax
shares rather than Howden Africa shares so the alignment is suboptimal from this standpoint.
Howden Africa has high barriers to entry and a durable competitive advantage from the installed based,
customer relationships, and the strong disincentive for an engineer to switch suppliers in a high risk
environment. Given the focus on services and spare parts, a new entrant would need to first create a
significant installed base and then wait out the first cycle of maintenance in order to gain access to the more
profitable component of the business. Additionally, they focus on the more technical parts of the market
which reinforces the higher switching costs. They also imbed themselves in their customers’ work processes
to increase customer stickiness. The majority of the airflow equipment in Eskom was installed by Howden
decades ago and this installed base is the key behind the attractive aftermarket business.
The business has generated five year average returns on equity of more than 50%, which reflects both the mix
of sales and the more technical areas that Howden Africa focuses on. The composition of revenues is 1/3 in
new builds and 2/3 in aftermarket parts. Aftermarket parts are more profitable than new builds but the
disclosure is weak around this so it’s hard to define the exact magnitude.
Howden Africa is trading on 7.6x 2015 earnings; however, two successful power projects came through the
Income Statement in 13/14 and as a result, earnings are likely overstated. The 2015 results were released
today and given the weakness in end markets, the YOY decline in operating profit was ~20% while the EPS
decline was ~20%. Even adjusting for these declines, the stock is trading on ~9x earnings. If you look at
five year average EPS, Howden Africa is still trading at a cheap valuation of 10x. Given their high cash
conversion, the FCF is roughly similar with FCF valuations of 12x the five year average and 16x ’15 FCF,
which is arguably after a very severe decline in new order activity. This is for a company that has
compounded book value at ~18% over the last 10 years. Also, ~1/3 of the market cap is in cash so the ex-
cash multiples are even more attractive and the business does not have any long term debt. Historically, the
business spent their excess cash flow on dividends and expansionary capex but the dividends have
temporarily been halted. The business is trying to comply with South Africa’s Black Economic
Empowerment (BEE) programme. As a result, they’re exploring a BEE transaction which could require
some of the cash. This was anticipated in 2014 but the transaction has been delayed into this year. The
company continues to state that it won’t pay a dividend until this is resolved. Overall, the potential for
dilution from a BEE transaction is a real risk and likely the biggest concern from the market. It is difficult to
quantify exactly how much would occur but arguably the valuation provides a significant margin of safety
against this. In addition, the company was a Level 3 BEE contributor (with 1 being the best and 8 being the
worst) in the 2014 Annual Report.
Trading volume has been light over the last month, with daily volumes ranging from $8,000 to north of $1m.
However, it does look like there are periodic blocks available.
~50% of Howden Africa’s revenues come from Eskom, the largest electric utility in South Africa. Given the
power outages that the country has faced, this issue is somewhat mitigated through the need to focus on
bigger issues than supplier concentration, but it is clearly a risk.
Also, the currency exposure is a potential concern. However, some of the risk is mitigated through USD
denominated contracts. For example, ~50% of the year end 2014 receivables were USD denominated. The
cost structure is also predominantly in South African Rand. Nonetheless, the ZAR still looks expensive based
on the interest rate differentials between the US and South Africa but the valuation compensates for this risk
in conjunction with their history of maintaining pricing power in real terms.
A very dilutive BEE deal, as described above.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


Colfax acquires the remainder of Howden Africa after a BEE deal. Howden Africa continues to compound
at an attractive rate given the current FCF valuation and its growth prospects across Africa. Howden Africa
previously paid a dividend and a return to a dividend, and even the possibility of a special dividend or
buybacks, might generate interest from some of the South African pension funds (such as Eskom, a sub 1%
owner) that own the stock.
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