Description
SCHINDLER HOLDING AG (SCHP SW) – Long
Last Sale: fr 195/sh
Market Cap: fr 20.9b
TEV: fr 18.2B (fr 2.7b Net Cash)
30 Day Avg Daily Volume: ~189k shares/day (~fr 39mm)
Investment Horizon: ~24-36 months
(all figures are in CHF)
Summary
Schindler Holding AG (SCHP) is a leading global maker of elevators, escalators and moving walkways. The stock is off >35% from its highs – it’s largest drawdown since the financial crisis of 2008/09 – as a myriad of headwinds and missteps have crimped profitability. While cyclical headwinds persist in the short term and estimates are likely to trend lower, we are encouraged by actions the company has taken; namely, the recent management change with the return of senior leadership from 2014-16, a time when the business expanded margins above trend and the stock outperformed peers. SCHP currently trades at a ~5% free cash flow yield ex. net cash, a fair (and historically cheap) price to pay for what is a very high-quality business that we believe is likely operating at around trough margin levels.
Business Overview
Schindler was founded in 1874 in Lucerne, Switzerland. Today, the Schindler Group is one of the world’s leading providers of elevators, escalators, and moving walks and is active in the areas of production, installation, maintenance, and modernization. It has operations in more than 100 countries.
Investment Thesis
The core points of our long SCHP thesis include:
Elevators are a “razor – razor blade” type of business model, whereby new installs are sold at a modest operating margin, and spare parts / ongoing maintenance services is performed at a much more profitable rate. In SCHP’s case, it’s estimated that maintenance comprises ~40% of sales and ~75% of operating profit. This type of split is positive as maintenance demand tends to be much less cyclical than demand for new equipment.
The Schindler family owns 47.2mm voting shares (SCHN SW), worth about fr 9b, and controls about 70% of the vote.
SCHP has a net cash position of about 2.8b (total cash of 3.9), representing >10% of its market cap. Needless to say, they are conservatively positioned and it would not be surprising if the company pays out a special dividend sometime in the next several years (as they did in ’15 and ‘17). They’ve been fairly conservative when it comes to M&A, and there’s not much reason to think that stance will change.
Given both disappointing operational performance and a previous strategic focus on growth over margin, SCHP’s board made several changes in management in January, most notably appointed current Chairman Silvio Napoli as CEO. Napoli was previously CEO of SCHP in 2014 to 2016, a time when the company achieved significant margin improvement as a result of their “Fast-Forward” program. This change to a more cost-focused manager is welcomed given the volatile operating environment the company faces today. Moreover, given his history with the company, there is no transition period.
After peaking at 12.0% in 2017, operating margins came down to 10.4% in 2021. Moreover, given labor and materials costs headwinds, consensus is forecasting operating margins ~10.0% in ’22 (and we expect that estimate to trend modestly lower). It is estimated that labor costs represented about 37% of sales in ’21, and materials about 30% (with steel representing 75%-80% of raw material costs).
The opportunity to expand margins beginning in ’23 will come from:
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Price catching up to cost in the back half of ’22 (and hopefully an abatement in the upward trajectory in commodity prices)
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Ongoing initiatives at SCHP that should continue to bear fruit, including a cost optimization program that still has 40mm incremental savings left to be realized in ’22, a Modularity Program that still has 30mm cost savings to be achieved by ’23, and their Top Speed 23 Program that was rolled out in ’21 with a goal of realizing 270mm cost savings by ’23.
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The benefits of a positive mix shift, as Maintenance sales expand over the next several years.
Management may lay out more formal margin guidance in H2’22. Providing a credible roadmap to getting back to 12% operating margins (or better) would serve as a material catalyst for the stock.
China represents ~18% of sales, and consensus is largely expecting China-derived sales down 10%-20% in ’22. With that being said, the China headwinds have been headlines for several quarters, and it seems like much of the bad news is baked into the share price. While not something we’re betting on, there is some speculation that China may look to do some sort of real estate stimulus program this year – this would obviously be a positive for SCHP.
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Attractive valuation
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SCHP is trading ~12.5x ’22 EV/EBITDA, below its 10-year avg mult of 14.4x, and at the low end of its typical 12x-18x range.
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As a thought exercise, we believe the value of the aftermarket business alone supports SCHP’s current enterprise value - ~1.1b ’23 Maintenance operating income taxed at 21% is ~865mm, which translates to a 4.7% earnings yield (ex. net cash), which is far from expensive for this type of earnings stream.
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With margins inflecting in ’23, we see a path for free cash flow to increase at a double-digit CAGR for several years. Along with the regular dividend, SCHP can earn a mid-teens IRR from the last sale though the ‘24/’25 timeframe.
Key Risks
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
- New guidance potentially laid out in H2'22, particularly relating to margins
- Capital allocation