Description

KNORR-BREMSE AG (KBX GY) – Long

Last Sale: €68/sh

Market Cap: €11.0b

TEV: €11.0b (€34mm net debt)

30 Day Avg Daily Volume: ~210k shares/day (~€14mm)

Investment Horizon: ~36 months

Summary

Knorr-Bremse AG (KBX) manufactures and services braking systems for rail and commercial vehicles.  Despite operating an attractive business model, KBX has been a chronic disappointment since the stock IPO’d in 2018.  Much of the damage has been self-inflicted, and with the recent/pending management changes, there is reason for optimism in this regard.  Externally, the headwinds are obvious (Europe macro slowdown, margin pressures, etc.) and with the stock trading at its lowest multiple since IPO (~8x ’23 EV/EBITDA) we believe much of the negative has been priced in.  With a record order book (at 12/31/21) and a view that growth and margins will likely trough in 2022, we are patient buyers of the stock.  Moreover, reports abound that numerous parties have indicated they would be interested if the Thiele family (controlling shareholders) considered breaking up the company; while this is perhaps not a near term (or likely) event it does highlight the optionality embedded in the portfolio should shares continue to disappoint.

Business Overview

Founded in 1905, KBX today is the world leader in brakes for rail (50% market share) and commercial vehicles (25%), by market share.  The company’s core competence is to be a system provider in braking, which includes hardware, controlling, software and service.  The strong leadership position is underpinned by its R&D leadership, which not only focuses on reducing total lifecycle costs for customers but also driving investment in new technologies.

KBX reports under two segments:

• Rail Vehicle Systems (RVS) – 49%/59% of ’21 sales/EBITDA

• RVS brands include : Knorr-Bremse (brake systems), IFE (entrance systems), merak (HVAC), Selectron (train control management) and Kiepe Electric (traction systems; bought from Vossloh in 2017).

• Brake systems account for about 2/3rds of the segments sales

• Per the company - RVS grew at ~3x the rolling stock market growth rate last decade

• ~45% of sales are aftermarket in nature

• >80% of sales are to transit rail customers (and <20% to freight rail)

• Commercial Vehicle Systems (CVS) – 51%/41% of ’21 sales/EBITDA

• ~2/3rds of sales were derived from braking systems products and services

• CVS has grown at ~6x the truck production rate last decade, supported by technological developments leading to truck automation and higher content per vehicle

• Around 30% of sales are aftermarket parts/services

Investment Thesis

The core points of our long KBX thesis include:

• Quality business model that is a strong generator of FCF throughout the cycle

Several attributes make KBX a high-quality business:

• High aftermarket sales - ~45% of RVS sales and 30% of CVS sales are aftermarket parts and services.  This should continue to grow as KBX’s installed base increases in the coming years.

• A relatively high ROCE of ~25%, very good for an industrial (and is probably suppressed given the excess cash that sits on their balance sheet).

• Strong FCF conversion – ~55% / >100% as a % of EBITDA/net income in recent years

• And, KBX has generated meaningful FCF every year since 2002, proving the businesses cyclical resilience.

• Recent/pending changes in management team and Board of Directors

In short, given several events – notably the unexpected death of Heinz-Herman Thiele and the head-scratching bid for Hella (both described below) – and the fact that shares have performed disappointingly, it was necessary to make substantial changes to management and the board.  These changes announced in March include:

• Dr. Reinhard Ploss, who is stepping down as CEO of Infineon (IFX), will be taking over as Chairman.  Ploss is highly regarded, and during his tenure as CEO of IFX (beginning 10/1/12) the stock has compounded at a >20% IRR vs the DAX at <7%.

• CEO Dr. Jan Mrosik will leave the company at the end of April after a short but unsuccessful run at the helm.  As Stifel put it: “As CEO, he was in charge of the unpopular and unsuccessful Hella takeover attempt and another unclear and unsuccessful attempt to establish a third "digital" pillar at KBX.  The latest capital markets day also failed to boost investor confidence or even to create "buzz", which, in a three-strikes-law fashion, was sufficient for the Supervisory Board to end the collaboration "in mutual agreement".”

• Current CFO Frank Weber will take over as interim CEO.  This instills some sense of continuity as Ploss and the board will begin their search for a new CEO.  And, importantly, most believe this also means the company is likely to maintain their medium-term targets announced only 6 months ago.

• Defined capital allocation plans post CMD

The bid for Hella (6/29/21) came out of left-field and blind-sided investors.  The stock fell ~20% until KBX withdrew their bid (7/7/21).  Nonetheless, the move scarred investor confidence, and was ultimately a major factor in the eventual removal of Mrosik.

Given the universally negative reception to that proposed deal, we believe the company found religion, and as they stated at their Nov ’21 Capital Markets Day, the clear M&A focus would be on deals of the bolt-on variety in rail and truck.  Given the Hella experience, it’s all but a given that the next permanent CEO will need to sign on to this measured M&A approach. 

Beyond M&A, the company will continue to spend ~5% of sales on average on organic growth initiatives.  Additionally, KBX pays a dividend and targets a 40%-50% payout ratio.

• Potential for a strategic transaction

Rumors abound that KBX could be a break-up candidate should shares continue to languish (German media outlet Manager Magazin reported this in Q1’22).  While management has not commented on the report, which indicated that there were “plenty” of potential suitors, a simple SOTP valuation (as discussed below) suggests separating CVS from RVS would create material value.

• High insider ownership

KB Holding, an entity controlled by the Thiele family, controls 59% of KBX shares.  Heinz-Herman Thiele, who had  been CEO (1985-2007), and  then Chairman of the Supervisory Board of Knorr-Bremse until 2016, unexpectedly passed away in Feb 2021 leaving behind a $20b+ fortune (KBX is their largest holding with a current value ~€7b).  The family has not indicated any intention to further sell down their KBX stake, though that could certainly change, especially if the shares continue to underperform.

• Attractive valuation

• KBX trades at about 8x ’23 EV/EBITDA – while only having several years of trading history, this is as cheap as the stock has traded.

• WAB (public comp to RVS) trades at ~12x ’23 EV/EBITDA.  While KBX should trade at a discount to WAB (given KBX’s truck exposure), the 4x gap seems too wide.

• What’s also worth noting, WAB’s 2-yr fwd EV/EBITDA mult has typically troughed at ~8x (where KBX is currently trading)

• On a SOTP basis the shares could be worth ~€100/sh (which may be relevant should rumors of a breakup come to fruition):

• Valuing CVS at the same mult as WBC was taken out at (11.6x EV/EBITDA) yields a ~€6.7b valuation

• This implies RVS is being valued at ~5.5x EV/EBITDA 

• Taking the above CVS valuation and assuming RVS trades at parity w/ WAB (~12x) yields a ~€16b TEV for KBX (vs the ~€11b it trades at today)

Key Risks & Concerns

KBX, like other European industrials, face significant headwinds at the moment.  And, given a multitude of known factors, it’s likely that sellside ests will come down further in the coming weeks/months.  Current headwinds include:

• Raw materials prices / components availability will likely weigh on near term margins.

• China exposure is ~19% total sales, and the country is considered and area of growth (particularly for CVS).

• Russia/Ukraine exposure is small (~2% sales).

There’s also risk related to the selection of the next CEO.  With Ploss soon taking over as Chair (and therefore in charge of the search) there is reason for optimism.

Catalysts

• CEO announcement

• Potential breakup

Catalyst

• CEO announcement

• Potential breakup