Description

NIBE SS is a short based on:

• Demand headwinds as pandemic tailwinds unwind and higher interest rates damper housing construction activity and consumer spending

• Massive wave of new supply entering the market

• Expensive absolute valuation and relative to its long-term historical average multiple

Business Overview

NIBE operates across three segments:

• Climate Solutions (65% of 2023 revenue; 79% of 2023 EBIT): The largest product category within the segment is the company’s heat pump business, which accounts for around 60% of the segment’s revenue. Other products in this segment include water heaters, climate control systems, boilers, and solar panels.

• Element (25% of 2023 revenue; 13% of 2023 EBIT): B2B business that produces components (e.g., heating jackets, resistors, heating cables, temperature sensors, etc.) for electric heating applications, including components for household appliances, HVAC, and industrial use cases.

• Stoves (10% of 2023 revenue; 8% of 2023 EBIT): Produces a wide range of energy-efficient stoves (including wood-burning, electric, and gas stoves). Also produces ancillary products such as chimney systems.

The business has been built in large part by tuck-in acquisitions. The company’s targets call for M&A to account for half of revenue growth going forward. The company generally takes a hands-off approach to acquired companies, who generally continue to operate their brands under their original trade name.

In terms of geography, 21% of revenue comes from the Nordic region; 47% from the rest of Europe; and other countries account for the remaining 32% (the vast majority of which is North America).

Demand headwinds

While the European heat pump market had been growing leading up to the pandemic, demand boomed during COVID as home improvement demand was pulled forward and many European governments introduced or expanded incentives for energy-efficient home improvements.

These trends have now begun to reverse. End market sales decreased 5% in 2023, the first Y/Y decline in over a decade. As COVID tailwinds continue to unwind and higher interest rates (which reduce both new home construction – which have higher rates of heat pump penetration than the general housing stock – as well as consumer spending) begin to weigh on demand, there’s likely further room for demand to fall.

Moreover, trends at the manufacturer level are significantly worse than at the end-user level. During the pandemic, distributors overloaded on inventory. Management has stated that it expects that distributors will have worked through most of this excess inventory by the first half of this year, but this seems optimistic (Barclays recently put out a note stating that their industry feedback suggested that the destocking headwinds would persist through 1H25, 12 months past the date suggested by management). Meanwhile, NIBE for its part has also seen its own inventory levels swell from SEK 4.4bn at the end of 2019 (17% of LTM revenue) to SEK 13.3bn (28% of LTM revenue).

New wave of supply

At the same time that the European heat pump industry is facing several demand headwinds, a huge wave of supply is entering the market. Over the next few years, capacity additions amounting to ~3.2mm of annual production capacity are coming online in Europe (some of this looks to have already come online recently). Note that this amount includes investments by NIBE itself (whose ~10bn SEK / €875mm investment program was originally announced in 2020, and has already been largely completed per the 1Q24 earnings call: “But as Eric mentioned, we are basically through our big investment program as well. So we will not see the same levels or amounts of investment going forward, as we've seen in the past.”).

This 3.2mm of incremental supply compares to 2.6mm total units sold in Europe in 2023. In other words, the incremental capacity coming online over the next few years will slightly more than double current supply.

In the near-term, the combination of 1) a huge wave of new supply; 2) excess inventory positions at distributors (and likely many manufacturers as well, if NIBE’s own inventory levels are any indication); 3) unwinding of pandemic-era demand tailwinds; and 4) higher interest rates will weigh on both volumes and margins. Given the magnitude of the supply coming online relative to demand levels, pricing could also suffer. With low-double-digit EBIT margins, even small price declines could have a large impact on profitability. Even looking out over the medium term, it will likely take several years for enough incremental demand to absorb this new capacity to emerge.

Expensive valuation

In spite of the challenging backdrop, NIBE trades at ~24.5x consensus 2025E EPS, a premium to its 22.5x average multiple during the 2006-2019 period.

Viewing it another way, the stock trades at ~15.5x consensus 2025E EBITDA. Another European heat pump manufacturer -- Viessmann -- was acquired by Carrier earlier this year (announced last year) at 16.5x EBITDA. With the stock trading around where a closer comp was taken out by a strategic, the multiple seems full in spite of the recent pullback. The range of outcomes for the multiple would clearly seem to skew to the downside.

Valuation and Price Target

See below for a summary of my estimates and price target.

Management has discussed returning to normalized EBIT margins of 13%-15% in 2025 once the company is fully past destocking headwinds. However, a return to pre-COVID margins seems highly unlikely given the wave of supply coming online. In my base case, I assume a 12.5% Climate Solutions segment margin in 2025. This is 50bps below the low end of management’s informal range (and 150bps below the midpoint), and ~150bps below the 13.8%/13.9% margins that the segment generated in 2018/2019. You can also arrive at my 2025 base case estimate of ~3.5bn SEK in operating profit for the segment by taking 2024 operating profit and assuming 30% incremental margins on low double digit volume organic growth, plus the 570mm portion of the company’s annual cost savings target that relates to the Climate Solutions segment (out of 750mm total) – though assuming any pricing pressure would suggest significant downside to this number.

Catalyst

• Consensus numbers come down further / misses vs. consensus
• Impact of new capacity additions becomes apparent (price cuts, etc.)