|Shares Out. (in M):||1,110||P/E||21||19|
|Market Cap (in $M):||197,000||P/FCF||0||0|
|Net Debt (in $M):||24,000||EBIT||0||0|
We propose buying Assa Abloy (B shares) trading below 175 SEK per share.
Assa Abloy is the world leading manufacturer of door locks and lock solutions. Its competitors include Dormakaba (German-Swiss), Allegion (USA), and Hörmann (German), but Assa Abloy is about 3x larger than their next biggest competitor. It had a profit warning 2 weeks ago mainly driven by a write-off in their China business, after which the share price dropped just a under 10%. Its shares have been fairly stagnant in the last 3 years although earnings and revenue has grown in that time and we believe will accelerate in growth going forward.
Business Description and Segmentation:
Assa Abloy manufacturers and distributes door locks including both traditional mechanical locks and newer electro-mechanical locks. On the whole, they assemble their locks and are mostly not involved in the heavy manufacturing part of the locks.
A few important segmentations of the business as as follows:
Segmentation by New Built vs. Aftersales
% of Revenue 2017
a) Aftersales/Replacement 67%
b) New Construction 33%
About 2/3 of their sales are for replacement components sold mostly to locksmiths or installers for maintenance/upgrading/replacement. While 1/3 of their sales are sold in new building projects where specifiers, architects, and consultants are invovled. On average the replacement sales is more profitable and has contributed to the relative stability of revenue and earnings in the underyling business (it didnt have a signficant decline in revenue or loss in the previous economic downturns including 2008). In some regional markets like China, sales are skewed to new construction.
Segmentation by Customer Segments
a) Commercial/Institutional 75%
b) Residential 25%
About 75% of sales are primarily products that go into public administrative buildings, offices, malls, stores, educational buildings. These are mostly complex projects and Assa has contact points with many stakeholders across the value chain. Distribution and installation are usually handled by installers, system integrators, and locksmiths.
In the residential area, we are talking about apartments mostly and homes, where Assa cooperates with door, window, and specialist smart home distribution channels like locksmiths and home improvement stores.
Geographical segmentation/Business segments
% of Total % of Total
Business Unit Revenues Op. Income Growth in 2017
a) EMEA 23% 24% 7%, 4%, 16%
b) Americas 23% 30% 8%, 4%
c) APAC 11% 7% 1%, 4%
d) Global Technologies 14% 15% -
e) Entrance Systems 29% 24% -
Total SEK 76.1 bn 9%
This is a bit of a mix between geographical and specific businesses. About 30% of revenues are in Entrance systems, which is different from door locks in that they are comprehensive solutions going into building projects from entrances to large skyscrappers to metro stations for example. EMEA, Americas, and APAC are then the divisions for the regional sale of locks, although there are some differences in that Assa owns the distriution mostly in Europe but not in the Americas.
Assa Abloy tries to involve their specialist sales people at the early stage of large projects – specifiers provide expertise and digital tools (teaching) in planning, specification, and design of door solutions for projects. Distributors then provide key role in support after installation. These are mainly security installers and specialist distributors.
Often Assa specifiers, which are becoming more important, work with architects, building consultants, security consultants, and building standards agencies. They use building information modelling (BIM)
The main international competitors are Dormakaba (German-Swiss), Allegion (USA), and Hörmann (Germany). Some of these are more focused on the residential market.
Overall, this is generally a stable industry where its hard to steal customers, but also quite sticky once you have them. Assa Abloy has some scale, especially around product development, which is important, but otherwise there is an element of good execution.
Assa Abloy has over the years converted their heavy manufacturing towards assembly. Product assembly is done close to the customer primarily in mature markets. Strategic components such as cylinders, rim locks, and some electromechanical products are concentrated in the company’s own manufacturing plants in low cost countries.
Assa Abloy spends 3% of sales on R&D and also measures a KPI which I think is very important - % of sales from products developed in the last 3 years. This is > 25% in the last 5 years. In 2017 the figure was 28%. In total, AB has 2000 people working on R&D across 114 regional competence centers close to the customers. They spend SEK 2200 million on this. Given that digitization is increasingly important in the area of locks, smaller competitors simply will find it more and more difficult to compete on the front of investing in new developments especially when it comes to software and hardware interfaces.
1. Assa Abloy has historically generated good growth (around 9% p.a. for revenues and earnings in the last 10 years) from a combination of organic (approximately 4%) and value accretive acquisitions (apporximately 5%). The orgnic growth is mostly due to the underlying market growth of high quality lock solutions and the trends of urbanization that should continue well into the next decades. On the acqusition front, Assa has strong track record for many years of making highly accretive acquisitions where they are meaningfully able to increase the margins or acquire technology that drives growth. Assa's management has repeately stated that they aim to and could achieve around 10% p.a. growth from 5% organic and 5% acquisitions. The market has clearly lost faith in the company and does not believe the management can achieve this. Partly due to their recent issues in China, but we believe having looked into that situation that it does seem more like a one-off than a structural problem with their acquistion strategy. The valuation suggests that investors do not believe that returns for the company can sustain at historical levels, which we do believe they can.
2. In fact, we believe that growth very well may accelerate in the next years due to the strong growth in electro-mechanical locks (including smart locks and number locks). There are a lot of reasons why electro-mechanical locks are growing quickly (> 10% p.a.). One reason is simply convenience and security. Another reason is that with sharing models like Airbnb being more common, a solution that doesnt require transfering of keys but that is also secure is essential. All in all, you can already see this growth today, and we believe this will only accelerate going forward. Assa Abloy is the company we believe is the best placed to capture this as they control the hard-ware/software edge especially for the larger projects/solutions, where one simple standard solution is insufficient. What is happening is that smaller competitors increasingly find it difficult to provide compelling electro-mechanical solutions - and even when they do, its almost impossible for them to continue investing enough into innovation to stay ahead. They simply do not have the scale. Even on the residential side, where smaller players can compete you see that the top brands Yale (owned by Assa) and Schlange (owned by Allegion) are gaining market share.
3. Electro-mechanical devices and solutions offer more add-on items and more frequent replacement cycles, which in the long run should mean higher revenues. Although this is still to be seen, there are indications that whether smart sensors or interconnected services there are potential new revenue sources for Assa that can be sold for the new electro-mechanical solutions. From some of their cases, there is also some evidence that people tend to upgrade these solutions more frequenlty - maybe every 10 years - instead of purely mechanical locks - every 25 years. All in all, there is a potential for higher revenues on the same customer base longer term.
All in all, we believe that Assa Abloy is a high-quality business with high returns on capital and high single digit revenue growth that can meaningfully accelerate in the next decade. A poor acquisition in China which we feel is a non-structural problem and the large write-down after the previous CEO had suggested the business in China was getting better has led investors to lose confidence in this business and the management team. We believe, however, that this has to do with house-cleaning as a new CEO has joined and wants to set up his legacy with a clean slate. We think the prospects of the company are in fact better in the next 10 years than in the last 10 years, and that even if they could replicate their level of success in the last 10 years, this investment would be a fantastic one.
Lastly, we feel that with its moderate leverage and its high % of sales from replacement parts that are necessary for their customers, the business should also be a bit more protected than most companies in case we have an economic downturn.
Profit warnings/poor earnings due to a temporary solution. A good company with good prospects that is a bit out of favor.
|Entry||07/19/2018 05:55 AM|
Just to add a bit on valuation. We believe that owner earnings (cash earnings after tax) not including costs for write-downs of around 9 bn SEK is reasonable for 2018 going up to about 11 bn SEK by 2020. On an Market Cap of 190 bn SEK, this is a PER of 21x going to a PER of 18x. Looked another way, based on cash earnings, the yield on EV (which is 223 bn SEK) is about 4% now going to 5% in 2 years. This isnt particularly cheap, but if the structural growth continues around 8-10% p.a. as we expect for many years, we get to a healthy > 10% p.a. TSR.
|Entry||07/19/2018 11:20 AM|
No horse in this race but I would say that dormakaba is an inferior company. Stating the obvious of course, given the valuation - market is telling you this already. I’d note that Assa Abloy have generally always covered their cost of capital, even during the financial crisis. I think the analysis of dormakaba is complicated a bit by getting accurate historical numbers pro forma for the merger, but I would hazard a guess that it is not the case for dormakaba, and the returns have certainly been more volatile. A lot of the growth among the top players in the industry also comes from rolling up smaller players. Assa Abloy have done hundreds of these deals over the years and have proved themselves to be adept at it, whereas it is not necessarily the case for dormakaba. I looked at dormakaba as a long earlier this year and, thank God, passed on it. I went through the strategy presentation from the CMD and have to say I was not very impressed – a load of fairly vague gobbledygook in there about strategic growth, cloud, etc. I think that one of the more senior guys is leaving as well (from memory) - got shunted sideways to a "head of integration" role after the merger - might hint more at a lack of clear/harmonious strategic visionI do not believe the risk/reward in Assa Abbloy screams value, to be honest, so perhaps this doesn’t answer your question on why one over the other, but dormakaba is clearly the ginger stepkid of the peer group. But maybe it is in the price (finally).
|Entry||07/19/2018 04:07 PM|
Thanks darthtrader for the quick reply. I think you stated the main points really well, so i will just try to add a bit to it. I think first, if you look at how the companies are run - Assa is run significantly better, returns on capital are better, margins are higher, there is less slack in costs. But i think between the lines, Assa has a corporate culture that is more long term oriented - investing heavily in R&D and being still relatively focused in their M&A. This all shows in the financials through the consistency in both top and bottom lines. Beyond that, I think in general the best in class player has some natural advantages in this business with both scale and density in sales/distribution being meaningful. I don't know DOKA as well as Assa, but my impression has always been that DOKA is managed poorly, which makes it uninvestible for me.
|Subject||Unrealistic growth targets|
|Entry||07/19/2018 09:16 PM|
I will give you that the 10% drop on the China issues is overdone, but as someone before me claimed, the valuation doesn't feel particularly compelling. No question this is a high-quality business/company, but hard to excited about the 5% FCF yield.
I would argue there are several other reasons why this stock didn't deserve to trade at such a premium valuation in the first place. One point where you don't elaborate enough is the 10% top-line growth (5% organic, 5% inorganic) the company keeps talking about. It's been so long since the company came anywhere near that number, it's a joke they still pretend it's realistic. You talk about the last 10 years' growth. Let's focus on the last 5: they've only hit 10% in in 2014, and that was with 4% organic and the balance from M&A contribution. The other 4 yrs, the total average is 5-6%, which includes inorganic growth. In the existing Assa porftolio, there's always one geography or the other that drags the global average down. As for M&A, I believe this company has grown so big in its industry that there are not enough M&A targets of size out there to allow it to get anywhere close to the 5% target.
This company would merit a premium multiple when it goes back to growing strongly. The last 5 years suggest there is a structural issue here (and/or unrealistic expectations) rather than just a one-off China issue.
If you want exposure to the security industry, I would argue ALLE offers a more credible roll-up opportunity (out of simply a smaller starting base) at a more attractive valuation.
|Subject||Re: Unrealistic growth targets|
|Entry||07/21/2018 08:42 AM|
I would agree that within the next 2 years, the 10% growth target top line (5% organic, 5% inorganic) will be very hard to achieve. I think the case is more that a growth around 6% (3% organic, 3% inorganic) can go to about a 8% growth (5% organic, 3% inorganic) in the next few years and PERSIST for a long time with a relatively high certainty. We believe that due to the trends of digitilization, faster replacement cycles, increased complexity, the organic growth can reaccelerate.
In that case we get to a decent TSR. But i agree, on a 1-2 year time frame, the valuation is not "cheap".