Description

KSB3 GR is a relatively compelling investment with one drawback: the shares are not very liquid (avg. daily volume is $300,000).

Based in Germany and with a global presence, KSB is the world’s 4^th largest pump manufacturer by revenues (€2.2B; 15,000 employees). The company has a reputation for high-quality products and German engineering, but was historically poorly managed and run largely for the benefit of its workers. Over the past decade, revenues were flattish, returns were single-digit and FCF was erratic as KSB did nothing about its bloated cost structure.       

In late 2017, Dr. Stephan Timmermann joined as its new CEO and hired Boston Consulting Group to conduct a strategic review. Last year, the company quietly began communicating its business improvement plan. It does not hold earnings calls, so the plan was presented only in its investor decks and annual report. Through (1) cost cutting, (2) the exiting of unprofitable contracts, (3) a greater focus on end markets with long-term growth in which KSB is strong, (4) an initiative to increase the penetration of high-margin aftermarket parts & services into its large installed base, and (5) management accountability, a new KSB should emerge with the following outlook:

·      Revenue growth of GDP + 1% going forward

·      Aftermarket parts & services increasing to 40% of revenues by 2025 from 35% today

·      EBIT margin increasing to >8% in 2025 from 4.8% in 2019

Beyond 2025, KSB has room to further increase the revenue mix of aftermarket—and expand margins—KSB currently services just 26% of its installed base. Flowserve and Sulzer Pumps derive 50% and 45% of revenues, respectively, from parts & services. Looking at margins for competitors isn’t of much help as they are all over the place – these pre-Covid (2019 or 2018) EBITA margins: Flowserve 10%, Sulzer Pumps 3%, Dover Pumps & Process Solutions 22%.

KSB’s EBIT should slightly more than double from the 2019 pre-Covid level of €107mn to €225 mn in 2025, assuming €2.5B in 2025E revenues and a 9% EBIT margin. KSB shares are cheap on 2019A EBIT (7.5x), but trade at just 3.5x EV/2025E EBIT. The company’s modest amount of net debt + pension should fall to zero by 2025 as FCF accumulates. (Note: KSB uses a very low interest rate in its pension calculation, inflating the amount. I’ve adjusted the value downward reflecting a more realistic liability).

Valuing the company at a more appropriate 12x 2025E EBIT and using its 2025E debt-free balance sheet yields a share price of just over €1,500 per share in 3-4 years – a 4.3x return.    

Founded in 1871, KSB has 2.6% global market share and is one of just a handful of global pump manufacturers – the others include Flowserve, Sulzer Pumps, Ebara and ITT. If the company were ever to be sold, a high-teens EBIT multiple would be in-line with precedent transactions given the quality of its brand and its scarcity value. A takeover valuation of 17x 2025E EBIT implies a share price of just under €2,200 per share – a 6x return.

If EU countries pass infrastructure bills to boost their Covid-weakened economies, KSB would benefit and its shares could see significant multiple expansion. KSB communicated a confident outlook in its 1Q21 trading update. In addition, the company recently became far more investor friendly. Last year, it hired Rothschild & Co. to survey its shareholders on how it could improve in IR. Typically, such surveys don’t result in major changes. At KSB, significant changes did occur. The company’s website used to look amateurish; it is now very professional and showcases a corporate video. Its investor presentations used to look home-made; they are now polished and top-notch. The company gained more sell-side coverage earlier this year and did two investor roadshows in May and June. It would not be surprising to see the Company present at European industrial or small-cap conferences and potentially begin holding earnings calls.      

The foundation which received the founder’s original shares owns 20% of the preference shares (KSB3 GR) and 84% of the ordinary shares (KSB GR) which are even less liquid. These two share classes historically traded in lockstep but the ordinary shares (KSB GR) recently began trading at a premium which today sits at 19%. Whenever such a premium developed in the past, it never persisted as KSB3 caught up to KSB.

While not very liquid, KSB3 is the lowest-risk way I know of to potentially quadruple a relatively small amount of money over the next 3-4 years.

Catalyst

·      A new KSB is emerging: EBIT should slightly more than double from 2019A to 2025E.

·      A greatly improved Investor Relations effort from a little-known company.

·      The potential passing of infrastructure bills in Europe. 

·      In the short-term, the closing of the gap between KSB3 and KSB.