Description

Norma Group (ticker:NOEJ.gr) is a German OEM of clamps and connectors for the auto, water management and general industrial markets in Europe and N.A. (auto is ~50% of mix, Water 30% and general industry 20%). This is a story of a good quality business and a champion in its niche  – NOEJ is 10x larger than the next competitor and sells products that make small percentages of larger systems, yet are operationally critical.  Over time NOEJ generated 20% after tax ROIC including G&W. It grows GDP+2-3% cycle to cycle thanks to structural tailwinds in the water management industry and content growth in auto.

The investment case for NOEJ is one of cheapness on normal, as we can own the business close to cycle trough.  NOEJ also benefits from reversion to the mean in margins on the back of a straight-forward restructuring program.  Combined, we see NOEJ generating e5 EPS in 3-4 years against a stock that trades for e38/share. Applying 15x to the business, value is 75e around 2024, which implies an IRR of around 25%.

Examining NOEJ’s history you will find that it had been producing ebita (opm before amortization of past acquisitions) of around 17.5% for many years all the way to 2017.  Margins then started to contract on the back of too many tuck-in acquisitions that were never optimized at the manufacturing and procurement level (duplicate sites, 100% local procurement by each division and region). In mid-2019 a new CEO and mgmt. team replaced the old guard, which did a good job on the topline side but was not active enough on the cost side, allowing margins to contract to 13%. The team embarked on a plan to remove e50mm of cost, or 5% of sales and return NOEJ to 17% ebita margins.  Of this e50mm, e25mm come from buying raw materials at central HQ (has been done at 32 sites separately), e20mm come from consolidating manufacturing down to 18 locations and e5mm come from trimming sub profitable products. Not rocket science, and our checks with formers indicate the goals are very doable. Management is razor focused on this plan and the org hears the message around efficiency daily. They should get there with possible upside.

A word about the business model and why NOEJ can generate 17% OPM margins (high for a typical auto supplier and industrial OEM). This is a company that produces over a billion widgets every year, with each unit costing e0.5-2 per piece.  For reference, a typical car has content of ~e90, made up of 40-50 units. These parts are designed into the model for 7-8 years. If they break the car goes into the shop. Reliability, relationships at the engineering department levels and low defect ratios mean a lot. Price is not that of a factor when selecting vendors.  And since NOEJ is 10x the next provider it usually prevents competitors from entering as it can price the incremental design to a loss for the sub-scale contender.  On the water management side, you want reliability as well, and brand matters given that you sell through wholesale distributors. Net, NOEJ operates in a niche within the industrial market that supports good pricing.  Further, NOEJ’s manufacturing is all about automation at scale and is built on machinery designed internally at the company – this has prevented low-cost country producers to compete as labor is simply not a factor when you make 1B units per year and each SKU is worth less than e25K on average.

Coming back to the current situation, NOEJ was on track to expand margins in 2021 by >100bps vs 2019 (2020 is not representative given demand collapsed with COVID). Then came the semi supply issue around June this year and management lowered guidance for margin by >200bps for 2021 (400bps reduction implied for 2h21).  The stock price broke and the market entered a wait and see mode.  However, the semi supply issue is transitory. Eventually it will pass, probably by 2h22, possibly early 2023 completely. Then we are back to cyclical recovery where the auto end market expand 10% in 2022 and 2023 to catch-up on pent-up demand and historically low inventory levels.  In this respect, we note that NOEJ earns the same level of content in the auto segment on BEV vs ICE so this isn’t a story of a secularly challenged supplier. Water continues growing above GDP, and the industrial biz is LSD.  All in we benefit from HSD revenue growth in 2022 and 2023 and then hold a business able to grow top-line at MSD that is still expanding margins.

The key risk to the thesis is an environment of continued raw material inflation.  NOEJ passes raw mats to customers under contract, but this typically lags by six months. Under accelerating rates of inflation margins will decline.  We don’t believe this is the base case on a multi-year basis, but to capture some risk on this front we underwrite normal margins of only 15.5% vs 17% target. We priced NOEJ on that scenario after giving the auto business a 12.5x PE (cyclical but grows 2-3% above industry), the water management segment 19x PE (structural grower with stable demand in down markets) and the industrial side at 16x PE (discount to overall market for cyclicality).  That view got us 15x blended PE, in-line with NOJE’s median historical forward multiple. It implies e75/share price target and 25% IRR.  We find this to be enough margin of safety to protect us from loss over time even under more severe scenarios.  Finally, we note that NOEJ trades for around 16x PE on depressed margins and still has about 250bps of margin benefit to flow through the P&L from the restructuring program – should the inflation scenario escalate, that buffer will further mitigate impairment of value.

Catalyst

Cycle recovers in auto

Margins revert back towards 17% ebita