Description

LEM is a Swiss company and leader producer of transducers, which are used to measure electrical current. Their products are used across a wide range of end-markets that need a precise measurement of electrical current, such as trains, electric motors, elevators, cranes, renewable energy, and automotive. Automotive include battery management, motor control, and charging systems. They've been transitioning from conventional engines (mostly lead-acid battery management) to EVs.

LEM enjoys good pricing power because transducers are mission-critical components, which ensure accurate regulation and optimize the efficiency of motors. But since they account for only a small part of the value of the final product, price is not the main consideration for customers, who are willing to pay a small premium for the quality and reliability of LEM's products. We believe that in industrial businesses gross margins are a key indicator and LEM’s >46% gross margins reflect the high technological content of the product and LEM’s pricing power.

LEM has more than 2500 SKUs, which implies very little dependence on any individual SKU for a customer. As an example, no customer accounts for more than 5% of sales. Assuming 100 SKUs for the largest customer, this would hardly represent USD 180,000 per SKU. This means there is very little incentive for customers to source cheaper products from other suppliers, as the potential savings are very small and don’t compensate for the risk of product failure.

Competitive dynamics are attractive, with LEM being the undisputed leader in the traditional industrial markets in which they operate, with 60% market share. Competitors are generally small divisions of large conglomerates for which transducers represent a very small part of their business and therefore lack focus. In newer and high-growth electric vehicle markets LEM has a lower, but still respectable, 20-25% market share. The transducer market is very small, with LEM being the clear global leader but still only generating roughly USD 400mn in sales, so it doesn't generally attract much competition. Even if competitors were to try to enter, there are entry barriers as customers choose suppliers based on trust and long-term experience. Sales are driven not only by product quality and price but also by long-lasting relationships. LEM's engineers cooperate closely with customer engineers for the design of new products.

Low-cost and efficient manufacturing is key to remaining competitive. LEM designs its own manufacturing machines, which is rare for an industrial business and acts as another entry barrier for competitors. All of this is reflected in LEM’s very high and consistent profitability, with 20%+ EBIT margins, more than 2.4x turns on capital employed, and more than 50% pre-tax ROCEs. The consistency of LEM’s margins and returns reflect a well-managed and predictable business, with strong visibility on demand and control of pricing.

We see little disruption risk, as currently there is no substitute for transducers. Therefore, we think LEM provides exposure to fast-growing markets like renewable energy and EVs in an attractive segment of the value chain, therefore avoiding some of the usual pitfalls which you typically see in these markets, such as hyper-dynamic technological development and competitive structure. Regarding growth, 50% of the business should grow in line with GDP and another 50% (renewable energy and EVs) should see double-digit percentage structural growth, for an overall 9-10% growth into the mid-term. As the sales mix shifts towards higher-growth segments consolidated growth should further increase.

Finally, we like LEM's management, which has demonstrated strong execution and long-term thinking. Five years ago, they significantly bumped up their R&D spend, from 6% of sales to 9%, while at the same time controlling SG&A costs. We believe that was a very well-though out move and we are now seeing its impact on growth. LEM is on 31x 2024 FCF, which we think is attractive relative to other industrial businesses considering the long-term growth potential and the quality of the business and management. 

Catalyst

Market share gains

Higher penetration of EV & charger stations, and market size growth accelerating.