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WEIR GROUP WEIR LN S
July 27, 2013 - 3:57pm EST by
Biffins
2013 2014
Price: 21.07 EPS $0.00 $0.00
Shares Out. (in M): 213 P/E 0.0x 0.0x
Market Cap (in $M): 4,490 P/FCF 0.0x 0.0x
Net Debt (in $M): 834 EBIT 0 0
TEV (in $M): 5,277 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

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  • Industrial Equipment
  • Oil Services
  • Commodity exposure
  • Peak cycle
 

Description

 
Short Weir Group.
 
Weir Group is a british maker of pumps for the minerals, oil & gas and power & industrial end markets. It has leading market positions in mining (slurry pumps) and unconventional North American natural gas extraction (pressure pumping). Weir experienced a tremendous growth over the last few years as demand for mining equipment increased tremendously as new projects were greenlighted on the back of China's stimulus in 2009 and demand for fraccing equipment outright exploded in 2009-2011 as the rush for fraccing equipment, specifically pressure pumping, create a tightening and pressure pumping dayrates skyrocketed. Both these divisions are going to come under pressure and Weir is a very timely short. The oil and gas division especially benefitted from the pressure pumping ordering surge (on which it makes good margins) and its EBITA went past the minerals division, but is set to crash back very hard. 

 
 

Minerals Division.
 
Global mining capex has peaked in 2012 and is set to decline in the years to come from its tremendous highs. There's a big writeup on Metso here on VIC that delves into this a lot further and I suggest you read it to understand why mining capex is going to be collapsing (and already has been). The usage of slurry pumps is extremely wide spread and touches almost all mined commodities. Hence Weir can be said to be attuned to global mining capex as opposed to particular commodities. Slurry pumps are used in mining of  Gold, Silver, Iron ore, Tin, Steel, Coal, Titanium, Copper, Mineral sands, Lead and Zinc. The recent decline in all commodities will just make things worse.

Slurry pumps are also pretty late in the mine buildout so projects that start construction on the mine 

The breakdown for the orderbook, revenues and EBITA is as follows (from company data).

 
Minerals     1H 08 2H 08 1H 09 2H 09 1H 10 2H 10 1H 11 2H 11 1H 12 2H 12 1H 13 E 2H 13 E 1H 14 E 2H 14 E
                                 
Input OE     210 209 152 146 210 211 291 238 311 218 249 196 236 196
Input OE - YoY %       -27% -30% 38% 45% 39% 13% 7% -8% -20% -10% -5% 0%
Input Aftermarket   194 193 211 209 273 287 371 365 415 384 394 307 355 292
Input Aftermarket - YoY %     9% 9% 29% 37% 36% 27% 12% 5% -5% -20% -10% -5%
Input total   403.4 401.1 363 355 483 498 662 603 726 602 643 503 591 488
                                 
Revenue OE           168 184 213 294 257 283 226 246 201 233
Revenue Aftermarket         253 299 338 373 403 391 392 328 343 307
Revenue total   339.6 402.8 384.1 431.5 421.8 481.4 550.8 665.5 664.9 668.7 617.9 574.2 544.2 539.8
                                 
EBITA     52.2 62.3 66.3 67.3 84.3 90.2 101.3 112.6 119.9 136 123.7 107.2 108.6 100.5
                                 
Op margin   15.4% 15.5% 17.3% 15.6% 20.0% 18.7% 18.4% 16.9% 18.0% 20.3% 20.0% 18.7% 20.0% 18.6%
 
 
Now it's clear that the OE input (new orders) already took a big hit in 2H 12 and collapsed from £311m in 1H 12 to £218m in 2H 12. The YoY% progression quite clearly indicates how the input peaked and will start falling. This isn't yet reflected in revenues since it takes about 9 months to fulfil an order. Infact I ran Solver to figure what OE input from previous semi-annuals best explains the revenues in any given half and it's about 91% explained by the orders in previous semi-annual (and 9% from the semi-annual before that). This makes sense since we know it takes 9 months to fulfil an order. This allows you to predict 1H 13's revenues with a high level of confidence. Doing the same exercise for the Aftermarket revenues and you get that the revenues for Aftermarket are explained about 74% by the Input in the same quarter and 26% from previous half. This also makes sense. 
 
What you can observe from this is that the 2H 12's orderbook collapse will have a big hit on revenues in 1H 13. Weir should already have collapsed once that data was revealed but it didn't because the EBITA was just peaking for the division then as you can see from table above. 
 
Weir also doesn't split the EBITA between OE and Aftermarket but you can again tease it out if you assume constant margins for those businesses to see what margins best fit the EBITA for the total Minerals division and I get 6% EBITA margins for the OE business and 26% for Aftermarket. This is also verified in discussions with management to be in the ballpark. So the big hit in OE will have a smaller impact on EBITA initially until the aftermarket collapses due to lower OE installed base. And if you follow the YoY% for OE and Aftermarket you can see there is another 6 months lag before the Aftermarket Input increased and also 6 month lag before it started following the OE input down. 

The effect is that the surge in new OE ordering that took place in 2H 10 and 1H 11 due to China's 2009-2010 stimulus, drove an increase in aftermarket sales and since aftermarket sales are higher EBITA margin, it drove EBITA higher, which just peaked in 2H 12 and should decline from here unlike expectations.


Oil and Gas

Weir benefitted from the tightness in the US pressure pumping market in 2010/2011 which led to massive new capacity being ordered by almost every player. The massive ordering, coupled with the collapse in US Henry Hub has led to massive pullback of frac fleets from the expensive regions (Haynesvilles, Barnett) and a collapse in overall rigs being deployed for gas. A lot of frac fleets have switched to being used for shale oil instead but the oily basis are not as shallow, and hence require a lot less horsepower as the pumping intensity required is less. This has exacerbated the glut of supply in pressure pumping, whose rates have collapsed. 

A lot of the new pressure pumping fleets still remain idle as companies wait to start fleets when dayrates recover. Utilization of existing fleets also remains very low. Any recovery will be a very slow long process. The last of the new pressure pumping fleets were being delivered in early 2013. Already in 2012 the business saw massive declines in new orders as you can see below.

Oil & Gas     1H 08 2H 08 1H 09 2H 09 1H 10 2H 10 1H 11 2H 11 1H 12 2H 12 1H 13 E 2H 13 E 1H 14 E 2H 14 E
                                 
Input OE     68 89 68 58 81 209 218 257 158 110 63 55 57 55
          -13% -35% 19% 260% 169% 23% -28% -57% -60% -50% -10% 0%
Input Aftermarket   87 87 87 92 143 194 176 211 215 196 194 167 155 150
          0% 6% 64% 111% 23% 9% 22% -7% -10% -15% -20% -10%
Input total   155 176 155 150 224 403 394 468 373 306 257 222 212 205
                                 
Revenue OE           92 102 168 217 252 132 117 70 56 57
Revenue Aftermarket         131 137 158 200 238 222 196 176 161 153
Revenue total   128.8 151.8 142.8 161.8 223.8 245.4 324.1 418.6 492.3 351.3 312.9 246.4 217.5 209.3
Revenue like of like vs yoy                            
                                 
EBITA     22.7 38.3 20 32.7 60.9 56.5 82.2 100.9 123 87.6 78.7 62.5 55.4 53.2
                                 
Op margin   17.6% 25.2% 14.0% 20.2% 27.2% 23.0% 25.4% 24.1% 25.0% 24.9% 25.1% 25.4% 25.5% 25.4%

Doing the same exercise as for minerals, the OE revenues for any given semi-annual are based 86% on the previous half's new orders, which again makes sense since delivery time is again about 9 months. And again for Aftermarket it's a mix, with 64% coming from current half's input and rest from previous semi-annual's input. Backing out the EBITA margins for best-fit gives 23% margins on OE revenues, and 26% on aftermarket. So unlike the minerals division, the OE revenues for Oil & Gas made good margins, and as that business collapses, it is causing a big hit on EBITA, which already fell a lot in 2H 12 and will continue to decline.

Power and Industrials

Weir also has a more stable Power and Industrials business which is a small part of the company. I've made some stable assumptions for the business but its main competitor Sulzer, just recently missed badly so even this business might not be as stable as it looks, but I've not investigated much further and it's not material.

Power and Industrial 1H 08 2H 08 1H 09 2H 09 1H 10 2H 10 1H 11 2H 11 1H 12 2H 12 1H 13 E 2H 13 E 1H 14 E 2H 14 E
                                 
Input OE     53 79 53 55 57 93 87 78 99 94 99 94 99 94
Input Aftermarket   86 71 86 72 82 41 76 71 96 72 96 72 96 72
Input total   139 150 139 127 139 134 163 149 195 166        
                                 
Revenue OE           46.3 68 81 92 85 85 94 99 94 99
Revenue Aftermarket         69.5 68 60 74 68 85 90 78 90 78
Revenue total   99.8 130.4 117.4 113.9 115.8 133.7 140.9 165.8 154.5 168.9 184.7 176.3 184.7 176.3
                                 
EBITA     5.8 12.2 7.9 15.5 9.8 16.5 8.6 18.2 11.7 19.8 17.6 15.5 17.6 15.5
                                 
Op margin   5.8% 9.4% 6.7% 13.6% 8.5% 12.3% 6.1% 11.0% 7.6% 11.7% 9.5% 8.8% 9.5% 8.8%


Valuation

I have Weir's sales and EBITA collapsing while the market expects it to stay stable, or even increase.

Total revenue (£m)   1H 08 2H 08 1H 09 2H 09 1H 10 2H 10 1H 11 2H 11 1H 12 2H 12 1H 13 E 2H 13 E 1H 14 E 2H 14 E
Minerals     340 403 384 432 422 481 551 666 665 669 618 574 544 540
Oil & Gas     129 152 143 162 224 245 324 419 492 351 313 246 217 209
Power and Industrial 100 130 117 114 116 134 141 166 155 169 185 176 185 176
Group companies   64 0 20 16 14 12 15 12 13 25 12 26 12 26
Total revenue   632 685 665 723 775 873 1031 1261 1325 1214 1128 1023 958 952
                                 
                                 
                                 
Total EBITA (£m)   1H 08 2H 08 1H 09 2H 09 1H 10 2H 10 1H 11 2H 11 1H 12 2H 12 1H 13 E 2H 13 E 1H 14 E 2H 14 E
Minerals     52 62 66 67 84 90 101 113 120 136 124 107 109 100
Oil & Gas     23 38 20 33 61 57 82 101 123 88 79 63 55 53
Power and Industrial 6 12 8 16 10 17 9 18 12 20 18 16 18 16
Group companies   1 1 2 5 2 2 1 2 1 2 2 4 2 4
Central Costs   -5 -5 -6 -5 -6 -6 -7 -8 -8 -7 -8 -8 -8 -8
Total EBITA   76 108 91 115 151 159 186 227 248 239 214 181 176 165
                                 
Total EBITA Margin   12.1% 15.8% 13.6% 15.9% 19.5% 18.2% 18.1% 18.0% 18.7% 19.7% 19.0% 17.7% 18.3% 17.4%

Weir itself managed to guide to flat/higher sales. The way it did this was to make an acquisition in January, and include its projected sales number in the guidance. The market clearly lapped that guidance up as headline numbers were Weir guidance beats forecasts. The firm it acquired, Mathena, also is a shale gas frac equipment maker, and hence levered to the same downturn. I expect this acquisition for $385m to be disastrous. I am unsure how much EBITDA or sales to add to the numbers for this acquisition, but I have added a decent guess based on talk with analysts/mgmt, and the fact Weir likely paid 12x EBITDA for 2012 and the business should be stable to declining near term. 

Weir's FCF yield should be collapsing going forward and it might have to cut the dividend. Weir will trade at less than 4% FCF yield and above 13x EV/EBITDA if my forecasts pan out, and that's way out of whack from where these businesses are currently valued or have been valued historically, or should be valued. As Weir misses on Revenue/EBITA and earnings expectations I expect the share price to correct.

Share Price   2,085.0                          
Shares fully diluted   213.1                          
M Cap (£ m)   4,443.1                          
                                 
      1H 08 2H 08 1H 09 2H 09 1H 10 2H 10 1H 11 2H 11 1H 12 2H 12 1H 13 2H 13 1H 14 2H 14
Cash       74 45 57 67 84 61 114 121 391 246 298 345 383
Debt       314 245 176 165 368 350 787 965 1080 1080 1080 1080 1080
Net Debt       240 200 119 98 284 289 673 844 689 834 782 735 697
Net Debt / LTM EBITDA   1.1 0.8 0.5 0.3 0.8 0.7 1.4 1.5 1.2 1.5 1.6 1.6 1.6
                                 
EV       4,683.0 4,643.1 4,562.3 4,540.8 4,726.7 4,732.1 5,116.3 5,287.1 5,132.0 5,276.8 5,224.7 5,177.7 5,140.0
EV / LTM EBITDA     21.1 19.4 18.3 15.0 13.1 11.7 10.8 9.7 9.0 9.5 10.4 11.6 12.0
                                 
EBITA of 3 divisions   76 108 91 115 151 159 186 227 248 239 214 181 176 165
Ammort     -8.3 8.2 -8.5 9.6 0.0 0.0 0.3 -0.3 0.0 0.5 0.1 0.1 0.1 0.1
EBIT     84.7 100.3 99.2 105.5 151.0 158.7 185.9 226.8 247.5 238.1 214.1 181.3 175.6 165.2
D&A     18.7 18.5 21.1 23.7 23.5 28.8 29.8 31.3 42.1 44.0 44.0 29.9 29.0 27.3
EBITDA of 3 divisions 103.4 118.8 120.3 129.2 174.5 187.5 215.7 258.1 289.6 282.1 258.1 211.2 204.6 192.5
Mathena EBITDA                       16.0 16.0 16.0 16.0
EBITDA     103.4 118.8 120.3 129.2 174.5 187.5 215.7 258.1 289.6 282.1 274.1 227.2 220.6 208.5
                                 
Working Capital   123.3 225.2 202.2 139.5 185.9 253.6 315.5 410.8 523.9 505.1 500 500 500 500
Change in WC   -47.6 101.9 -23.0 -62.7 46.4 67.7 61.9 95.3 113.1 -18.8 -5.1 0.0 0.0 0.0
                                 
Interest     7.8 9.4 8.0 10.7 6.9 8.0 7.5 11.9 21.5 25.0 26.2 26.2 26.2 26.2
Taxes     18.4 30.6 21.8 21.8 29.2 43.2 42.6 71.6 65.8 58.4 50.9 42.0 40.5 37.7
Net Capex   20.2 33.1 17.9 22.7 18.3 32.6 33.0 62.4 53.0 70.6 70.6 70.6 70.6 70.6
                                 
Levered FCF - run rate 57.0 45.7 72.6 74.0 120.1 103.7 132.6 112.2 149.3 128.1 126.4 88.3 83.3 74.0
LTM FCF Yield         3.3% 4.4% 5.0% 5.3% 5.5% 5.9% 6.2% 5.7% 4.8% 3.9% 3.5%
                                 
Levered FCF (incl NWC) 104.6 -56.2 95.6 136.7 73.7 36.0 70.7 16.9 36.2 146.9 131.5 88.3 83.3 74.0
Mathena acquisition                     -276.25 -36.3 -36.3 -36.3
Change in cash                       -144.8 52.1 47.1 37.7
 
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

 Poor earnings that miss expectations.
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