| 2016 | 2017 | ||||||
| Price: | 179.00 | EPS | 8.8 | 12.7 | |||
| Shares Out. (in M): | 5 | P/E | 20.3 | 14.1 | |||
| Market Cap (in $M): | 800 | P/FCF | 0 | 0 | |||
| Net Debt (in $M): | -193 | EBIT | 54 | 78 | |||
| TEV (in $M): | 607 | TEV/EBIT | 11.2 | 7.8 | |||
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Rieter
A) Thesis Summary
Rieter is a Swiss-based global market leader in the manufacturing of spinning milling equipment that converts short staple natural and manmade fibers into yarns. These yarns are among other things used by the apparel industry.
The investment thesis is based on two pillars: (i) a cyclical recovery of the demand for spinning milling equipment – currently in a down-turn and close to 10-year low, (ii) business and operational improvements driven by the new CEO Norbert Klapper.
The market is not pricing Rieter correctly. At as sustainable EBIT of CHF 100-120m the company is valued at 5-6x EBIT.
B) Business Analysis
1. Introduction to the Apparel Industry
Before we start the discussion of the business and the investment thesis it is worth explaining the structure of the world apparel industry by type of fiber.
% of Tons % of Materials in Spun staple Fiber Yarn
a) Short Staple 48% 100%
i. Cotton 29% 61% (Preparation & Spinning machinery)
ii. Manmade 15% 31% (Only Spinning machinery needed)
iii. Viscose 4% 8% Can be in filament form also
b) Filament 40% No Rieter machinery used
c) Long Staple 8% No Rieter machinery used
d) Non-woven 4% No Rieter machinery used
e) Total 100%
The key point is that Rieter equipment is only suitable for short staple fiber applications. Machines for filament fibres are based on a different technology. This poses the risk of substitution among different of fibers.
Historically manmade filament fibres have been eating share from cotton, but the production of cotton has remained stable in volume terms. This has been largely in functional wear (e.g. sportswear) and partly in daywear/street wear. Filaments fibres have superior economics to textile producers, yet despite the development of filaments, they have not reached similar properties (e.g. skin comfort) to cotton. The table shows the evolution of textile mill consumption (in mill tons) over the 2000 – 2015 and makes this point:
2000 2010 2014
- Textile mill consumption 53 76 90
- Cotton 22 24 24
As % of total 42% 32% 27%
- Manmade filaments 16 30 41
As % of total 31% 40% 45%
- Others 15 22 26
Our primary research suggests that this trend will continue at a similar pace that we have seen in the past – i.e. there is not disruptive trend in the textile industry that would accelerate
2. Segmentation Overview
In FY 2015 the revenue and profitability mix looks as follows:
Revenues % EBIT % Margin
- Machines & Systems 702 68% 15 20% 2,1%
- Aftersales 140 14% 27 35% 18,9%
- Components 195 18% 34 45% 17,3%
- Total 1037 100% 75 100% 7,2%
Machines & Systems: Manufacturing and selling of Rieter spinning mill equipment. This is the traditional Original Equipment ("OE") segment. The industry is currently in a down-cycle.
Aftersales: Parts, Services & Installation of Rieter products. This is the classical aftersales business.
Components: These are critical parts for spinning machines sold to third parties. Spares for 3rd party OEM installed base represents 80% of sales and components sales directly to 3rd party OEMs into their OE represents 20% of revenues.
Revenues from aftersales and components activities are recurring – thus ~ 80% of the operating earnings are fairly stable and shielded from the cyclicality of the OE business.
The OE business is depressed in revenues in profitability (due to operating leverage) as capex in spinning milling equipment for short-staples is currently in a down-cycle.
3. Competition
The industry of spinning milling equipment manufacturing for short-staples is highly consolidated with the Top 3 having 80% of the market. Market shares look as follows:
Country Market Share Comments
a) Rieter Switzerland 30%
b) Jinsheng/Saurer China/Swi 30%
c) Jingwei China 20% Only Standard technology, mainly in China
d) Lakshmi (LMW) India 10% 90% of revenues in India, 60-70% market share in India
e) Trützschler German 5% Only Preparation
f) Others 5%
g) Total 100%
Our customer interviews suggest that the 3 most important purchasing criteria are reliability, productivity and service – with price the least important. For example our customer interviews confirmed that it is important to have the machinery manufacturer close to advice and help to improve productivity.
In this context Jingwei has difficulties in selling equipment outside China as it is perceived as inferior by customers. Rieter’s strongest competitors are Saurer and Lakshmi.
a) Saurer: is Rieter’s strongest competitor. Our primary research indicates that in high-end equipment both are at par in terms of performance.
b) Lakshmi: (for now) manufactures equipment of slightly lower quality than Rieter and in addition they do not have yet a good service network outside India – this will take some time.
4. Investment Merits
4.1 Investment Merit 1: Cyclical Recovery
Capex spinning mill equipment for short-staple fiber is cyclical. Over the 2006 to 2015 the cycle showed the following patterns:
- It averaged CHF 2,6-2,7bn
- The peak was in 2007: CHF 3,6bn (2007)
- There have been 2 troughs of CHF 1,6-1,7bn in 2009 and 2016.
- The cycle is currently close to the trough seen over the last 10 years as cotton prices have declined significantly since 2011 – in real terms cotton prices are at an all time low. Low cotton prices lead to low profitability at the spinning mills, which then delay the replacement of the equipment.
We expect the cycle to reverse to mean, which would be somewhere between CHF 2,4bn. This is roughly 10% below the 2006-15 average to factor-in productivity improvements on the generation spinning mill machines.
The cycle bottomed in 2015 and has recovered since then: e.g. order intake for Rieter in Machines and Systems has developed as follows:
H1’14 H2’14 H1’15 H2’15 H1’16
Order Intake (CHFm) 494 340 226 232 343
4.2 Investment Merit 2: Increase Aftersales Business
The new CEO Norbert Klapper has made growing the aftersales business a key strategic pillar for the business. This business was historically not pursued very aggressively. E.g. in 2015 the CEO established a new organizational unit with direct responsibility and accountability for aftersales has been created within the group.
The strategy is based on 2 pillars:
a) Increase captivity from a low base. Currently Rieter has approx. 40% captivity. The share is higher in the US (80%) but lower in India/China.
b) Increase service offering. Service and maintenance of Rieter machines are done primarily in-house by the customer. Our experience in other capital goods industries is that often this is inefficient. As a result more than 90% of the Rieter’s aftersales revenues come from spare parts, and very little from services.
The strategy is to proactively approach customer and offer service solutions with the goal of improving the ROI of the customer. Our interviews with customers at the ITMA fair indicated that:
- Customers are interested in such solutions as is a very good approach and very value adding for the spinning mills, even if he did not buy any additional service
- They had been audited by Rieter recently.
At the ITMA fair (in xxx 2016) Rieter announced that it aims to grow aftersales revenues “by more than 30% from 2014 to 2018”, i.e. from CHF 128m in 2014 to “more than CHF 166m” in 2018. This will improve mechanically the profitability of the company as aftersales are much more profitable.
4.3 Investment Merit 3: Cost Cutting
The cost cutting potential comes from basically improving the plant network which in 2015 was as follows:
Factory Employees (blue collar) Cost /employee(€k) Labour Costs(€m)
a) India 1.100 10 11
b) China 800 12 9,6
c) Czech Republic 1.000 15 15
d) Germany (Ingolstadt) 500-800 60 30-48
e) Switzerland (Winterthur) 1.000 100 100
f) Total ca. 5000 165-183
Strategically it makes no sense to have two plants in the DACH area. A lesson learned is that Eastern Europe is very cost competitive with China in terms of total labor cost.
The company has announced reduction of personnel at the Germany and Switzerland plants. E.g. The reduction in Winterthur was published on October 20th 2015, it should save CHF 15-20m per year. This will add 1,5-2,0% to the group’s profitability. Part of the Winterthur production is being relocated to Czech Republic, China, India. The move is almost complete, some normal issues ramping up new production overseas but nothing to worry about.
C) Management
1. CEO
1.1 Assessment
Norbert Klapper was appointed CEO of Rieter in January 2014. He comes from Voith (manufacturing of paper machines) where he was CEO of different subsidiaries: Voith Industrial Services (2005-10), Voith Turbo (2011-14). I.e. he has the right profile/experience for the job.
He has a very strong focus in customer-added value and knows how to exploit it financially. He appears to have good leadership skills.
Our reference checks from people that have worked with/for or supervised him have been generally positive. Interviewees stated unanimously that he is sharp – and his intelligence is guided by business sense.
1.2 Incentive Scheme
The variable performance-based remuneration can be up to 100% of basic salary and is linked to current year targets vs. budget:
- EBIT – 60%
- RONA – 20%
- Free Cash Flow – 20%
These are decent KPIs for the incentive scheme.
D) Valuation
At the current price of CHF 179 the company has a market cap of CHF 800m and EV of CHF 607m.
Our estimates for revenues and EBIT are as follows:
2014A 2015A 2016E 2017E 2018E / Mid-Cycle
- Revenues 1153 1037 970 1070 1220
- EBIT 85 73 64 96 122
- EBIT margin 7,3% 7,0% 6,6% 9,0% 10,0%
- EV/EBIT 7,2x 8,4x 9,6x 6,4x 6,1x
The key underlying assumptions for 2018E (assuming that the cycle recovers by then and thus representative of a mid-cycle level of earnings) are:
Source of Revenues 2015 Mid-Cycle Comments
- OE revenues 702 820 OE Market Recovery of 20% from 2015 to ca. CHF 2,4bn
with Rieter keeping their share
- Aftersales 140 175 ~ + 30% in-line with management guidance
- Components 195 225 ~ 15% growth
- Total 1037 1220
E) Risks
1. Substitution of Short-Staple Fibre for Filaments
If the use of short staple fibers would decrease this would be an important risk for Rieter as their machines have no use in the production of filament fibres.
F) Catalysts
Acceleration of order intake.
Acceleration of order intake.
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