Description

Summary:  Nilorngruppen is a label and branding company based in Sweden.   We believe the company’s asset light model will allow it to earn significant returns on capital while also continuing to grow its customer and revenue base in the next several years.  The company has minimal debt and will generate excess cash that should be distributed to shareholders through dividends.

Business Overview:  Nilorn was started in 1970 as a design firm.  The company now makes over 1.5 billion labels per year, mainly for use by the garment industry.  Nilorn assists its clients with label design, manufacturing and logistics. Its customers are mainly European, while the company's supply chain is mostly in Asia.

Key Pillars of the Thesis:

1. Essential product for the customer.  Nilorn continuously works to embed itself as an essential part of its customers' supply chains.  
2. Blocking and tackling approach to the business.  We believe that Nilorn is extremely well-run, with a management team focused on continuous small improvement that brings large overall results.
3. Opportunity Even in a Slower Market. Though its overall market is not particularly fast growing, Nilorn has several opportunities to continue to drive top and bottom line results.
4. Solid Balance Sheet and Returns on Capital.  The company uses low leverage, generates 35+% ROIC, and pays out excess cash in the form of dividends.
5. Attractive Valuation.

#1.  Essential product for the customer.   Nilorn has over 1,000 customers, most of them European fashion, textile and branding companies.  For these customers, the label is an essential part of the overall brand. Labels reinforce the image, brand and identity of the garment. They view the label as the "jewel in the crown" that decorates a garment.

Labels do bring their own logistical complexities.  Nilorn has customers who have 700-800 labels sourced from 300 suppliers around the world. Even with this complexity, labels are generally only 0.5-2.0% of the final cost of a product.  Thus, the customers need a supplier who can produce reliably in the most efficient manner possible while handling the logistical needs of a potentially complex supply chain.  

In its early days, Nilorn built up a fairly significant PP&E base of factories around Europe.  During the late 2000s, the company recognized the lack of flexibility and high fixed costs inherent in this model.  Thus, they decided to refocus and create a much more asset-light, high-return model. As a first step, they sold off many of the factories so they could be much more flexible.  The company sources over 85% of its product from external suppliers.

They also took numerous steps to integrate themselves as closely as possible into the customers’ supply chains:

First, they moved to a much more distributed operations.  Sales and marketing offices are largely in Europe, where they can meet face-to-face with customers.  They also opened small offices in all major garment-manufacturing countries around the world so they can manage production closely.  At each of these offices, Nilorn has given the local manager significant authority over interacting with customers. The company claims this model has allowed them to be a global player, with economies of scale, while also being a local operator.

Second, now that they have eliminated many of their fixed assets, they can scale quickly at low cost.  They are comfortable that they have more than enough suppliers available to allow for flexible operations.  They publicly claim to be able to deliver labels to customers within 48 hours.

Finally, they have focused on IT offerings that allow them to integrate into customers’ inventory management and ordering systems.  For example, they offer Autoorder, a system whereby whenever a client orders something from a manufacturer, they automatically order labels from Nilorn.    

The end result of this strategic transformation is to maintain a large number of long-term customers while allowing Nilorn to gain market share.  .

#2.  Blocking and tackling approach to the business.   We believe that Nilorn management has done an excellent job of growing and managing the company.  Claes af Wetterstedt, CEO since 2009, was the architect of the company’s current strategy. At the company since 1989, he partnered with investment firm AB Traction to take the company private, sell off certain assets, and focus on the asset light approach.  They relisted in 2011.

Although operating in a very different industry with different competitive and growth dynamics, Wetterstedt and his team remind us of the management team from Mettler-Toledo, an investment we held (very successfully) for a number of years.  Nilorn's management is not swinging for the fences with a bunch of glamorous projects each year. Rather, they have focused on prudent growth, cost management, and tinkering with operations to optimize results. They do a number of small things that add up to significant results.  For example, in the last several years, the company has repeatedly emphasized its focus on improving internal processes to shorten lead times to customers. They are also willing to modify some of their typical tactics if it will lead to higher quality customer experience. For instance, they opened their own facility in Bangladesh because they needed to be near customers and could not get the quality and reliability they wanted.  

#3.  Opportunities for growth even in a slower market.   The global label market is about SEK 70b, and grows about 2% per year.  Over the past 5 years, Nilorn has grown significantly faster than the market, with average topline growth of 15%.  Looking forward, their long-term targets are revenue growth in excess of 7% with an operating margin of at least 10%.   

We believe there are several factors in Nilorn’s favor that should allow it to continue to grow faster than the market and gain share:

• They are still quite small relative to the market, with approximately 1% share.  They have a limited presence in a number of countries (e.g. they only entered Italy a few years ago) that should allow them room for growth as they hire additional local sales people.
• Increased consumption of European brands (Nilorn’s key customer base) in emerging markets
• Growth in new technologies like RFID, where Nilorn has invested significant resources.  Though RFID has been promised for years, the company says that prices for RFID have now come down enough that RFID labels make sense.  They are investing heavily in this area. RFID is still small relative to the overall market. In 2017, the highest estimates assume it is maybe 20% of the total addressable apparel market.  

In the event of an economic slowdown and resulting slowdown in the label market, we believe there are 2 factors at play that can help to limit downside and could even offer paths to growth: 

Small acquisitions:

Prior to its 2008/09 restructuring, Nilorn made a series of acquisitions, often destroying value in the process. Since 2007, they have only made 1.  In 2017, the company acquired some product capabilities, the inventory and customer list of of a Danish competitor for 0.7x revenue, 0.5x if adjusted for the inventory they received.  While the label market does have a handful of large competitors (Avery Dennison is globally the largest with >20% share), there are numerous small mom and pop operations, some of which must be capital constrained.  It would not surprise us if Nilorn started to make opportunistic acquisitions if any its competitors start to face financial stress.

Flexible cost structure in a downturn:

Prior to the 2008/09 restructuring, the company had its own in-house label production. Over a number of years, they shut down much of that production and began to outsource to partners.  Today, only 10-15% of annual production is done in-house. Much of their cost base is variable, giving them the ability to manage margins in a downturn.

#4.  Solid Balance Sheet and Returns on Capital.  Debt is limited and excess cash is returned to shareholders.  At June, the company had SEK71mm in debt versus SEK51mm in cash.  While management had guided that net liabilities should not exceed 2x EBITDA, they are currently running <1.0x TTM EBITDA.    Because of the limited capital required to run the business, the company generates 40+% returns on equity and 20+% returns on assets.  Given their excess cash flow generation, they have a company goal to pay out 60-90% of after-tax profit in dividends.  In the past 5 years, they have paid out between 73 and 99 of net profits.  In 2016, they paid dividends of SEK34mm, paid SEK41 in 2017 and should return approximately SEK 45mm this year.     

#5.  Attractive Valuation.  The stock currently trades for 14x 2018 estimated earnings of SEK6 and has a 4.9% dividend yield.  If the company can continue to grow sales at 8% per year the next several years and maintain margins, they should be able to generate approximately SEK6.75-7.00 in 2020 EPS.  As well, we expect the company to generate approximately SEK150mm in excess cash flow from now through the end of 2020.  At 14x EPS plus the accrued cash (either kept on the balance sheet but likely paid as dividends), this yields a SEK115 stock, up 40% from here.

Catalyst

Execution