Description

Summary

Nilorn is a high-quality business with a strong balance sheet where we view the current share price as an attractive entry point. Currently priced at 7-10x normalized EBIT, we find this to be an attractive entry point for a business that generates +30% return on capital and +5% growth p.a. We have patiently been waiting for sell side estimates to come down, which they have slowly during the year to now a level that we find reasonable. Given that it is a relatively small cap company (mcap 60m EUR) with limited trading this only suits small funds and PAs.

Business

We would recommend reading the VIC post from skca74 from September 2018 for more background.

Nilorn is a Swedish business founded in 1977 and is best known for producing labels/tags for clothing. This is a niche market where Nilorn is one of Europe’s leading players, but with a global presence. Its vision is to be “The best label and branding company worldwide”. 

What is the product and how does Nilorn make money?

Nilorn is known for being a label production company, but it is in our opinion much more than that. It has a large employee base of skilled designers who are working closely with its customers in making sure the brands get the deserved profile through nice labels and packaging. The company is integrated into its customers supply chain and only accounts for a fraction of the production cost. The company provides logistics and inventory management for its customers (for labels and packaging), so the warehousing/production footprint of Nilorn provides significant value for its customers. Nilorn has invested heavily over the last decade to make sure it is able to have the right product, in the right place, at the right time. We like businesses that have high switching costs, the product provides significant value for the customer, and the portion of the production cost is very low. 

Below on the right you see a few pictures of Nilorn’s products and how they help position the customers’ products. It is worth noting that Nilorn also provides the standard tags that are boring, but most of the products include significant design value and also value-add in terms of sustainability. Sustainable sourcing has always been a key selling point for Nilorn, being a Swedish company it was early on with sustainable sourcing (Swedes are crazy about paper/forest). 

Although having its outspring from Sweden and Europe, it has now established a global production footprint which allows it to produce labels close to its customers. It has local design studios primarily in Europe, but is able to follow the global brands to their global production sites. We believe H&M is a good example of a customer that Nilorn has followed globally with the outspring from Sweden.

We view this as a business where you need to have local design agents that capture customers, but they again need to be able to offer a global production footprint to capture the large customers who produce in several countries. Take Massimo Dutti as an example who produces its clothes in Spain, Portugal, Turkey, Bangladesh, India etc. In order to justify this footprint, you need a large enough customer base to fill these manufacturing sites with significant volume. In sum, we view this as a business with scale advantages and switching cost. 

Market and competitors 

With only ~100m EUR in revenue and ~10m EUR EBIT it is not a very large revenue/profit opportunity, something we like as it does not provide enough incentive for someone outside the industry to invest significant time and capital to attack this opportunity. Further, the products it produces (primarily labels but also packaging, buttons, RFID tags etc) is not a significant part of its customers cost base, but it can add significant value to the brand, meaning its customers have better opportunities to increase its value/share of the profit pool in the value chain than attacking Nilorn. 

Avery Dennison (listed in the US) is the best peer that we know of. Looking at its financials you also get evidence that this is a good part of the value chain to be present in, generating 9-10% EBIT margins and 15-20% return on equity. The previous post asked what prevents Avery Dennison from crushing Nilorn, and being over 10x the size of Nilorn there is no good way to answer this. Avery can definitely provide the same employment opportunities to Nilorn’s designers, and invest in the same distribution and production footprint if it wants to. On the other hand, we believe Avery benefits from having a competitor that makes ~10% EBIT and this return on capital, which justifies the pricing of Avery’s products. With Avery trading at 18x EBIT (with EBIT estimates for 2023 roughly in line with actuals 2022), we rather view it as an opportunity that Avery might acquire Nilorn rather than try to kill it off. 

There is no clear evidence in the financials that Avery is performing better than Nilorn. Since 2004, Nilorn has grown its revenue by 7% p.a. vs Avery at 4% and this includes quite a bit of M&A for Avery. Operating margins and return on capital are higher for Nilorn than Avery. 

Below is the financial performance for Nilorn over the past decade. It has a goal of growing revenues by 7% p.a. with an operating margin above 10%, which it has surpassed during this period.  

The graph below shows sources and uses of capital over the past 11 years. The business is highly cash generative and uses a small portion of its CFO on working capital and capex. The NWC build up in 2021 and 2022 is a result of tremendous growth, and although we do not adjust our EV calc for it, we would not be surprised if it released a significant portion of capital from NWC over the next 12 months. 

Valuation and situation 

The share price was 70 SEK pre-covid but fell as low as 22 SEK on the fears that the world would shut down and people would stop purchasing clothes. We all know what happened since, consumers stopped spending money on travel and stimuli checks/subsidies started coming in, creating an abnormal demand for retail products, including clothes. At its peak, Nilorn traded up to 120 SEK but is now again down to 55 SEK on the fears that the consumer will stop shopping due to high inflation and interest rates. 

At the current price the market cap is 600m SEK, 140m debt incl. IFRS 16 leasing, and 100m cash, meaning an EV of 640m. I would like to note that NWC is quite high given high recent sales that could be expected to release some cash now that sales slowdown.  

Although it is not likely that it will be repeated in the short term, this business generated ~120m of EBIT during 2021/22. On average, we would expect this business to generate 65-85m EBIT, meaning you are buying a high RoCE business that is almost net cash for 7.5x-10x EBIT. 

We find the current share price attractive measured against the EBIT we expect this business to generate, especially when we factor in the limited risk given its strong balance sheet. 

Estimates for 2023 were way too high going into 2023, so we have waited for estimates to come down to where it is easier for the company to not disappoint the market. The valuation has come down to where it has roughly traded on normalized earnings before, around 10x. The combination of these two events means that we feel the risk/reward currently is much better.

Risks

• Declining RoCE since it was listed, indicating that return on incremental capital is lower than before and competition might be increasing

• Risk that H2 EBIT and 2024 will disappoint current market expectations

• “Homeshoring” means that Nilorn will have to invest in more production facilities in Europe/US, and that its production facilities in Asia will have less strategic value

Catalyst

- Company prints growth and 60+ EBIT in 2024