Description

Polytec (PYT) is an Austrian-listed automotive supplier of plastic injection molding parts and components. It supplies a number of OEMs but has particular exposure to the German OEMs, with VW group representing 40% of sales, Daimler 14% and BMW 7%.  It tends to be a key supplier, claiming to have 25-100% market share depending on the product.  

PYT enjoys a very attractive valuation, trading at 5.5x '16 expected earnings, with a net neutral cash balance and a 3% dividend yield.  In addition, PYT should benefit from both macro and micro tailwinds:

A cyclical recovery in European autos - with the exception of a flattish month, European auto sales had been down year over year for 19 consecutive months into mid 2013, and have started to improve since. In addition, our conversation with industry players seem to indicate that German OEMs are executing the best in the region, both in terms of product and market share, which is where PYT has more exposure (60% of sales).

New customer wins and higher penetration on existing platforms - given the nature of the backlog, management has very good visibility through 2015/2016 revenues based on orders placed and talks with its customers.

Technical capabilities: Also important to note that as part of our due diligence, we spoke to a number of buyers to assess the Company's technical reputation and were impressed by the positive level of feedback.  One customer told us PYT was more technologically advanced than peers, and anecdotally we heard that PYT delivered a higher quality level than expected by another customer. PYT has a large group of skilled engineers, with over 100 registered patents.

Why is the opportunity available:

This is not a large cap company (€180M) with a 72% free float given a family control, and traded in the Austrian exchange.

Company guidance for flat 2014 sales hides the sales and operational momentum at PYT: there is a ~€20M negative impact to sales from PYT exiting certain non-auto commodity plastics businesses.  Those businesses are  non-core, and management decided to free up the badly-needed space in its plants and replace it with auto-related business. Essentially PYT would have been able to post organic growth of over 5% if not for this change, but with the production capacity right sized the company should be positioned for faster and more profitable growth in the following years.  In addition, their sales assumption assumes no cyclical pick-up in the European auto market, even though the order book seems to be pacing slightly ahead. Re operating profit, PYT has taken charges on its P&L in 2013 and 1Q14 for the retooling of 2 of its 22 plants, which will not re-occur in 2015, so we estimate pro-forma operating margins to be running closer to 6%, prior to any operating leverage from new platforms.

Company has not provided pro-forma numbers, clouding the underlying improvement in profitability: Q1 reported numbers showed a 10bps margin contraction, but those are related to restructuring.  We believe excluding those charges, PYT would have posted a substantial margin improvement.

Valuation: PYT has medium term targets of €600-650M in sales with 7-8% operating margins. At a 7% top-line CAGR, we get to €583M in sales by 2016 and ~€1.48 in eps (assuming incremental margins in the mid-high teens, and a tax rate of 25%).   PYT has historically enjoyed an 8x average multiple, which we think is reasonable, if not conservative. Without needing to assume any multiple re-rating, we get a target price of €11.80 by next year, or a 45%+ upside.  The current dividend yield of 3% is a nice addition to the total return profile of PYT.

2013A

Sales: €477m

Operating Profit: €21m

OP Margin: 4.4%

Net Income: €16m

EPS: €0.70

# of shares: 22.3m

2016E

Sales: €583m

Operating Profit: €46m

OP Margin: 7.8%

Net Income: €33m

EPS: €1.48

# of shares: 22.3m

Uses of cash: we believe that PYT's capex should exceed D&A over the next few years, but it should be all internally funded; aside from potential M&A (Co claims those are not necessary but they will be opportunistic), they want to be recognized as a solid and steady dividend payer (in 2013, had a 35% payout ratio)

Catalysts:

As new orders from the backlog start flowing through, those are expected to come in with a stronger margin (we estimate that incremental margin on these new wins could exceed 15%).

Reported operating margin to reset as retooling costs come to a close by year end

Increased penetration with existing customers: BMW is a case in point -  it used to be a 20%+ customer, but dropped to ~7% once PYT divested the interior systems division to Toyota in mid-'11.  PYT is now getting new orders for injection molding parts and we can envision BMW becoming a 10%+ customer again, despite the strong growth with VW.

China: PYT’s penetration into China through VW could be another driver of earnings. PYT recently signed a pact with VW China to initially supply oil pans for gear shifters on 4 cylinder cars with initial revenue of €10m annually. The company has stated VW has thrown out a €50-100m revenue target potential in 5-7yrs upon successful execution (implies supplying of other products). Plant will be 1,500 sq meters and can easily double or triple capacity within a year if needed. There are also talks of supplying other existing customers (ie Volvo & BMW) in a similar type fashion in China.  Production is set to start in 2016.

Pick-up in European auto demand growth

Extension into additional products

Risks:

M&A - we believe that the large deals of the past are unlikely, and PYT has not done a deal in over 2.5 years. Since its formation in 1986, the company has acquired 20 companies, all small to mid-sized except for the larger ill-timed Peguform acquisition in 2008. PYT usually acquires companies or assets in weak financial position, sometimes in coordination with customer OEMs, where synergies or operational improvement can be executed quickly.   

Resin prices - seems resin prices are rising, but while those are not pass through, PYT seems to be able to price those in when setting new contracts

Health of German OEMs, particularly VW

Catalyst

As new orders from the backlog start flowing through, those are expected to come in with a stronger margin (we estimate that incremental margin on these new wins could exceed 15%).

Reported operating margin to reset as retooling costs come to a close by year end

Increased penetration with existing customers: BMW is a case in point -  it used to be a 20%+ customer, but dropped to ~7% once PYT divested the interior systems division to Toyota in mid-'11.  PYT is now getting new orders for injection molding parts and we can envision BMW becoming a 10%+ customer again, despite the strong growth with VW.

China: PYT’s penetration into China through VW could be another driver of earnings. PYT recently signed a pact with VW China to initially supply oil pans for gear shifters on 4 cylinder cars with initial revenue of €10m annually. The company has stated VW has thrown out a €50-100m revenue target potential in 5-7yrs upon successful execution (implies supplying of other products). Plant will be 1,500 sq meters and can easily double or triple capacity within a year if needed. There are also talks of supplying other existing customers (ie Volvo & BMW) in a similar type fashion in China.  Production is set to start in 2016.

Pick-up in European auto demand growth

Extension into additional products