Description

Investment case summary

Marel is the global leader in poultry, meat and fish processing equipment and software. Based in Iceland, the company is undiscovered by many investors despite its excellent history of creating shareholder value. It is led by an excellent owner operator, Arni Oddur Thordarson, who is directly aligned with shareholders and has shaped Marel into the great company it is today through excellent capital allocation (he is definitely a strong candidate for The Outsiders 2). Marel is really in the perfect spot for long-term compounding. It is 4x the size of the next competitor, but still operates in a very fragmented market with ~20% share, giving it a great opportunity to grow through acquisitions. As the industry becomes more digitized, economies of scale become even more important and the moat should continue to widen. With the underlying market growing at 4-6% p.a., Marel’s >40% incremental RoTC, the company is cheap despite trading at multiples that most would consider expensive 17x EBIT and 20x EPS (net cash).

Business description

Marel was founded in Iceland in 1983 by a few engineers at the University of Iceland. The name comes from combining sea (Mar) and electronics (El). More specifically, the beginning of the company was based on the need for fishermen to accurately weigh fish as they were being processed to minimize giveaways, and Marel developed an electronic scale that could withstand the harsh environment and measure accurately despite the rocking from the boat.

Today, Marel is the global leader in poultry, meat and fish processing equipment. It sells automated equipment to process live animals into finished product. As an example, when Tyson wants to build a new poultry processing plant it can purchase the entire end-to-end slaughtering equipment line from Marel with overarching software. Such a slaughtering line consists of many steps and it is crucial that each machine is perfectly synchronized with each other as the fastest lines goes at 15,000 birds per hour (BPH) – yes that is more than 4 birds per second being killed, feathered, gutted, deboned, cut, etc.

Although the speeds and equipment are very different in meat and fish processing, the type of solution delivered is very similar. Marel has developed several machines that are used in multiple proteins, showing one of the benefits of being a “cross-protein” provider. Marel is one of very few players in this industry that serves multiple types of proteins (Baader is really the only other to be cross-protein, but has a weak position in poultry).  

In addition to selling equipment and software to greenfield projects, Marel has a very strong aftermarket business that generates significant cash flow. The combination of the aftermarket business and the global presence across 3 proteins make the business very well diversified, which is important given that greenfield capex in each local market and protein is cyclical.

Marel also offers its customers a software solution that allows for a fully integrated production system, with analysis, reporting, billing etc. The software is called Innova and reaches across all three proteins. This is a hugely untapped opportunity, as Marel is currently focused on building out the capabilities of Innova, while getting customers to implement it, before it will start pushing the software more aggressively. Although the software is old, the increased focus on the software side of the business is fairly recent. The company hired an executive from Microsoft, recently doubled its software staff from 40 to 80 in 2019, and will hire another 40 in the US in 2020. Software is now only small single digits of the revenue, but long term we should expect closer to 20%.

Marel reports its segments by proteins, with the current split in 2018:

•  Poultry: 53% of revenues and 67% of EBIT
• Meat: 32% of revenues and 25% of EBIT
• Fish: rest

Below is a picture of how Marel thinks about the business, showing the application gaps that will be filled either through R&D or acquisition:

Management and history

The Marel we see today is really the result of a carefully planned and well executed plan put forward by the current CEO, Arni Oddur Thordarson and his father. In order to understand the true value of Marel, one must understand Arni and his clear vision and strategy for Marel.  

A great investor I know only invests in a business if he can study the actions of the CEO over a 10-year period. Luckily for us, Arni has had significant influence over Marel since 2004 when Eyrir Invest (controlled by Arni and his father) purchased a controlling stake in Marel giving us 15 years of history to study.

Arni Oddur Thordarson – Current CEO (a true owner operator)

Arni graduated with a business administration degree from the University of Iceland in 1993 (MBA from IMD in 2004). After spending 8 years as a banker, he found himself drawn towards the opposite side of finance and incorporated Eyrir Invest with his father in 2000. In the early years, the investment company ran a “traditional” trading book, but in 2004 it changed its investment strategy to “invest in industrial companies that were already established as technical leaders and transform them into global market leaders.” The following year, the company purchased controlling stakes in Marel and Össur.

In 2005, Arni became the Chairman of Marel and the transition to a global leader began. I would recommend anyone considering investing in Marel to read the interview with Arni from 2008 when he received the Icelandic Business Award. In this interview he clearly explains the strategy he implemented at Marel. As a long-term investor in a compounder, it is reassuring to read old strategy documents and see the consistency with today’s strategy. Marel has clearly defined what it can do better than others and is consistently working on widening its economic moat.

In the interview, he explains how he believes companies either make a profit through economies of scale or highly specialized services. In 2005, Marel had 4% market share while the largest competitor had 8% market share, so it was crucial for Marel to grow at a rapid pace to win market share. He presented a 10-year strategy plan, first 5 years focused on external growth followed by 5 years of operational excellence and organic growth.

The external growth phase was completed in 2 years after it acquired Stork Food Systems, Scanveagt, and AEW Thurne with revenues of EUR ~400m, ~100m, and ~30m, respectively. In comparison, Marel had EUR 130m of revenues in 2005. Through these strategic acquisitions Marel became the global leader in protein processing and has never looked back, now being more than 4x the size of the closest competitor.

Stork Food Systems

Without going into too much detail, the Stork acquisition was crucial for the success of Marel as it is the foundation of Marel Poultry, which is the largest and most profitable part of Marel today.

Period of synergy extraction, organic growth and new CEO (Arni)

Following the aggressive growth through M&A, the plan was to start the integration process and extraction of synergies, followed by a period of organic growth. Unfortunately, the GFC hit right after the acquisitions, making the situation quite difficult for Marel that was highly leveraged at the time. To compound the leverage problems, Marel had taken on debt in the wrong currency (believe it was ISK). The company has since learned (a lesson mentioned by Arni in meetings) and has now aligned the currency of its financing its cash flows.  

The company did not really manage to (the CEO at the time did not think it was possible) extract the synergies that Arni envisioned and in 2013 he decided to take on the role as CEO. In 2014, he launched a restructuring program labeled “Simpler, smarter, faster” with two key goals: 1) combine business units that serve the same customer needs and rely on the same technical capabilities 2) optimize manufacturing footprint to balance utilization of resources within the company.

The results: EBIT margins went from 6% in 2013 to 15% LTM, organic growth of 12% p.a., and the share price went from EUR 0.8 to 4.0.

MPS

After the acquisition of Stork, Marel was an end-to-end provider in poultry processing but lacked a strong presence in the primary processing of meat. In 2016, Marel acquired MPS which was the global leader in primary meat processing at the time. Not only was it a strategically important acquisition as it cemented Marel’s dominant position in meat processing, but it was also a very attractive acquisition financially (~10x EBIT for a business with negative tangible capital).

2017: 10-year strategic plan

Arni is a long-term thinker exemplified by his 10-year strategic plans. In 2017, he launched a new strategic plan with a target of 12% annual revenue growth over the next 10 years, with 4-6% being organic and the remainder through M&A. EBIT and EPS should grow faster than revenues.

A key driver for the organic growth is to continue to invest 6% of revenue into R&D, which means with its sheer size Marel is investing multiples of competitors in innovation.

Since 2005, Marel has delivered revenue growth and EPS growth of over 20% CAGR (7% organic) and 17%, respectively.

2019 dual listing in Amsterdam

In 2019, Marel decided to dual list its shares in Amsterdam in order to enter a global stage for its company. The company issued some shares (after making repurchases in Iceland) in order to increase the liquidity in Amsterdam, but the liquidity in the stock has been fairly limited since the listing. To us this indicates that the company is still below the radar for most investors or is too small (yet) to be of interest.

Capital allocation

Arni has proven himself to be an excellent capital allocator. He ticks many of the boxes outlined in The Outsiders having done several large acquisitions, use debt strategically, and recently been a frequent repurchaser of Marel stock. The only thing missing from Thorndike’s list is a large disposal, although it is hard to see what that would be given the synergies across the current business units (he has done smaller disposals of non-core businesses).

Market

According to Marel the underlying market will grow 4-6% p.a, while Frontmatec (key competitor in Meat) recently put out a bond presentation highlighting that it believes its high-end red meat processing market should grow by 13% p.a. until 2023.

It is hard to estimate what the growth rate will be, but one thing we firmly believe is that this market will grow faster than GDP. There are several growth drivers here; equipment replaces labor (which is becoming increasingly expensive), new equipment improves yield (kg sold / kg processed), increased demand for traceability, increasing middle class, need for different meat cuts as consumer preferences changes, more ready to eat meals, etc.

The return on investment from investing in new equipment for Marel’s customers look fantastic on paper, often cited at below 1-year payback period. However, the problem for Marel’s customers (and the opportunity for Marel) is that as soon as one company upgrades its equipment, its competitors also must upgrade to the new equipment. All savings are passed on to consumers, but the equipment upgrade is necessary to stay in business. This gives significant power to Marel, a power we do not foresee changing in the near future and if it does it should change to the benefit of Marel, not the protein processors.

Marel estimates that the market size is: 3.0bn EUR for poultry, 5.5bn for meat, and 1.5bn for fish, making the total addressable market 10bn. After careful discussion with Marel’s management, we have learned that it is really only 60% of this that Marel targets today, as the remainder is lower-end equipment that Marel does not provide. However, the lower end of the market is moving up as automated equipment gains adoption among smaller customers.

This means that Marel has 20% market share globally in the addressable market, leaving significant room for growth, both organically and through M&A of smaller companies.

Competition

With >1,200m EUR of revenue in 2018, Marel is by a wide margin the dominant global player in this market. No other company is present in all three proteins, with the majority only present in one.  

Polutry

The main competitor in poultry is Meyn, with 275m EUR sales it is the second largest player in this market after Marel’s 650m. The company that was previously owned by a PE fund in Norway (Altor) and is now owned by Berkshire Hathaway (through CTB, Inc.). Baader Linco is the third largest with 120m EUR sales, followed by Foodmate with revenues of 50m EUR, and a long tail of specialized local players.

Meat

In meat there is really only one competitor, Frontmatec, which is owned by the Danish PE firm Axcel. Frontmatec is a consolidation story that was started in 2016 and has now acquired 9 companies that combined has an LTM revenue of 220m EUR (as of H1 2019). It is now in the market to raise a 165m EUR bond (bond presentation provides further details on the business), and there are rumors that it might be filing for an IPO soon.

As most companies in this market is small family owned businesses, it is very difficult to find a comprehensive list of competitors, but we firmly believe the list is long given that Marel and Frontmatec combined generate only 600m EUR of revenues vs a 5bn+ market. It is worth noting that meat is the least automated protein among the three and is therefore less consolidated than the other markets.

Fish

The main competitor in fish is Baader out of Germany with ~200m EUR of revenue, placing it ahead of Marel with its 160m. In addition, there is Valka out of Iceland, founded by a former Marel employee in 2005 that is gaining significant traction with its equipment considering the small size of the company (25m EUR revenues)

JBT

JBT is the only listed competitor in this space, but it only provides further processing equipment (no primary or secondary) and also has an aerospace business making it difficult to use as a comparable to Marel. Just as a reference, JBT is trading at 18x EBIT with 1.5x EBITDA leverage.

Importantly, the further processing business at JBT is a result of a series of acquisitions of what seems to be unrelated businesses (some sales synergies) that are operated as separate businesses within JBT.

Possible new entrants?

In order to enter this market organically one would have to have extreme patience, and it would probably still be almost impossible. The machines sold in this market is perfected over several decades, integrated into complex systems with software, protected by several patents. The development cycle for new products are extremely long, sometimes it takes 20 years before a new version of a machine is released.

The only real way to enter this market is to acquire a company that already has an installed base with a large aftermarket sale that provides cash flows to fund new product innovation. After Frontmatech acquired SFK Leblanc there is no other company out there of scale with a strong aftermarket presence besides the key competitors mentioned above.

Financials and valuation

One of the most impressive things with Marel is its 40% return on tangible capital (or 42% return on incremental capital since 2004). A large part of this is due to the power Marel has over its customers, forcing customers to prepay 30% of the order before Marel starts working on it, gradually increasing to around 80% around the time Marel makes the shipment. The combination of these prepayments and an assembly like business model, means that Marel does not need significant capital to grow. The result is that Marel converts more than 100% of its EBIT to FCF after capex.

Another thing to note is that Marel does not adjust its EBIT, except for amortization of acquired intangibles into EBITA. This is despite the fact that the company has had significant costs associated with the secondary listing in Amsterdam this year, restructuring of salesforce, and implementation of ERP and production software. According to management, these are parts of running the business and should therefore not be adjusted out. Impressive!

Combining the significant growth opportunity ahead (organic and through M&A) and the impressive return on capital, we believe the stock is cheap on its current 17x EBIT and 20x eps (net cash). We expect Marel to continue to compound shareholder value at a rate of 10-15% per annum going forward, although it will not be linear.

Risks

Poultry accounts for 67% of EBITA and the US has just been through a massive investment cycle in poultry where Marel (Stork) has a very strong position. North America is 29% of group revenues so the exposure to US poultry should not be that material.

This is a capital goods business that is exposed to the normal economic fluctuations, so a recession will hit the order book and stock price. However, a recession would probably be good for Marel long term as it is net cash and it could open up the opportunity to make some significant acquisitions. 

Catalyst

• This is a steady compounder that will create value for long term shareholders over time. Although hard to predict the timing of such an event, the company is net cash after the recent equity issuance and therefore investors should expect a larger acquisition in the near future. The company has a target of being 2-3x leveraged and Arni is known for his use of leverage.
• African swine fever have wiped out 50% of the pigs in China (which produce 50% of the pigs in the world). In the short term this creates demand for pork from the US and Europe, which helps Marel’s customers. In the medium term, China is working on expanding its poultry production capacity to fill some of the protein glut (it takes a few months to produce a chicken, while it takes 4 years for a pig). In the long term, this should be positive for Marel as the pork industry in China will consolidate into larger companies which are more likely to purchase advanced equipment, and increase investments in traceability etc. Overall, this should be a very positive thing for Marel (although sad for China) that is not yet reflected in the order book or stock price.