|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||860||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
Bodycote International Plc (ticker BOY LN on Bloomberg; price: 265.75p) is a British company that provides thermal processing and testing services to manufacturing companies in virtually every sector of the world economy from 300 facilities in 30 countries. It is the leader in thermal processing and testing, and the scale benefits from its position are evident in its margins. Trailing EBITDA and EBIT margins are 22.6% and 14.6% (well ahead of “engineering” comps). Return on capital is 17% - defined as trailing EBIT / (net working capital + net fixed assets). The company trades at 7.0x 2007E EBITDA and 6.4x 2008E EBITDA (over 2 multiple points below engineering comps). The sectors in which Bodycote operates are very fragmented, with numerous “mom & pop” operators. This permits the company to make accretive acquisitions at ½ to 2/3s the EBIT multiple at which
The company has two strategic business units: Thermal Processing and Testing. The Thermal Processing business unit accounted for 74% of sales in 2006, and has two primary divisions, Heat Treatment and Hot Isostatic Pressing, as well as a small metallurgical coatings division. The Testing business unit, accounting for 26% of sales (up from 18% in 2005), also has two divisions: Materials, Engineering & Technology Measurement, and Health Sciences/Environmental.
There are many different kinds of heat treatment services Bodycote performs. These services change the properties of the metals and other materials, and depending on the treatment can make them stronger, harder, softer (to enable metalworking), or straighter, or can join metals together. Hot Isostatic Pressing is used to better bond different materials. For example, a diamond tool can be made more wear resistant through HIP.
Just a few specific examples of the kinds of things Bodycote does: they treat many components that go into engines and transmissions of cars (gears, sprockets, etc), and they do hot isostatic pressing for BMW engine blocks and heads. They treat many components that go into jet engines and power turbines and treat drills and other components for oil and gas rigs. To do the heat treating they use specialized furnaces. These are expensive so to the extent they can increase utilization rate they spread the cost out so that it’s lower per unit (like any fixed asset intensive business). So they don’t run just one shift, and would like to run 24/7 if possible in order to utilize the equipment more.
Of all the heat treatment that’s done in the world, about 20% is subcontracted to companies like
There are hundreds and hundreds of subcontract heat treatment companies, and a few big ones, of which
Bodycote’s Testing unit has over 100 different labs in 19 countries, and provides independent, accredited testing for clients in materials testing, health sciences, engineering & technology, environmental and measurement.
In the western hemisphere BOY is the leader in thermal processing, competing predominantly with local, privately-owned companies and manufacturers’ in-house departments. In Hot Isostatic Pressing BOY has 60% of western hemisphere capacity since few manufacturers invest in this expensive technology.
As noted above, the portion of total revenues from Testing increased to 26% in 2006 from 18% in 2005. This is in line with company’s strategic plan (adopted after a thorough review in early 2005) to increase the contribution from the Testing business as the company believes it will give an improved ROCE and is less cyclical than Thermal Processing. The company aims to increase Testing to half of group revenues. The company’s strategy also calls for expanding into developing manufacturing geographies and to intensify outsourcing initiatives. The company measures its performance against strategic goals using progress towards financial KPIs (5 year targets) such as ROCE in the mid-teens % (reached 10.8% in 2006) , return on sales in the high teens % (reached 14.3% in 2006), organic sales growth in the mid/high single digits % (was 5.5% in 2006), and personnel costs as a % of sales of 40% in Thermal Processing (was 40.7% in 2006) and 50% in Testing (was 51.8% in 2006). The company also has non-financial KPIs such as Utilization in Heat Treatment of >80% (was 72% in 2006), ISO 14001/17025 compliance in all 300 facilities (184 facilities met this in 2006) and accident frequency of zero (versus 2.2 per 100 man-years worked in 2006).
In the ROCE measure, the Hot Isostatic Pressing division (as noted above, one division of the Thermal Processing business unit) and Testing business unit are above target, but the Heat Treatment division (the other main division of the Thermal Processing business unit) is not performing as well and is the company’s focus for improvement. The company is focusing on improving Heat Treatment’s capacity utilization (key to hitting ROCE target), and 2006 saw a small improvement over 2005.
2006 saw sales up 18.6% to £558.6mm. 5.5% of the sales increase was from organic growth and 13.1% was from acquisitions. Increasing demand came from markets such as aerospace, power generation, oil & gas, and health sciences. The Thermal Processing business unit had 2006 sales of £413.9mm, up 7.6% over 2005 (of which 5.2% was organic growth), comprised of £375mm from the Heat Treatment division and £38.9mm from Hot Isostatic Pressing (“HIP”). HIP had operating margins of nearly 33% compared to 13.4% in Heat Treatment in 2006. The Testing business unit had £144.7mm of revenue in 2006, up 67.3% over 2005 (6.6% of which was organic) with an operating margin of 14.7%. In the Testing business unit, Materials, Engineering & Technology Measurement had sales of £99.6mm (14.3% operating margins) while Health Sciences/Environmental had sales of £45.2mm (15.6% margins). After £4.7mm of central overhead costs group operating profit was £79.7mm for a 14.3% overall margin. 2006 saw strong demand in most sectors with the exception of automotive in
The company’s strong performance continued in H1 2007 with sales up 13.7% (6.3% of which was organic growth). Operating profit improved 18.7% to £48.2mm and operating margin increased to 15.2% from 14.5%. Testing comprised 27% of H1 07 sales, up from 24% in H1 06.
Geographically, 64% of revenues come from EMEA markets, 34% from the
I believe there’s a perception that Bodycote’s business is more cyclical than it actually is. I looked at the decline in EBITDA from the fiscal year before 2001 to the FY after 2001 for Bodycote versus the peer group of
Another point worth noting is that although Bodycote is exposed to the auto sector, Bodycote’s profitability with the auto sector is affected only by volume drops (not auto price declines), which don’t change all that much. A 5% drop in auto volumes is large, yet considering how diversified their customer base is, this shouldn’t impact
Major sector exposure is as follows: automotive and aerospace each account for around 20% of revenues, and oil & gas and power generation each account for high single digits % of revenues. Next come engine and transmission components for other transport uses (construction equipment for Caterpillar & Komatsu, locomotive, marine engines, etc). So in the widest sense, the vast majority of work is in transport systems of one type or another.
The final point about cyclicality is that back in 2001 Bodycote had no business in emerging markets. Now they’re in
History of bid from Sulzer:
Bodycote became an unsolicited acquisition target of Swiss company Sulzer AG earlier this year (ultimately unsuccessful). The background of the Sulzer bid is as follows. In January 2007, the share price of
Sulzer said that over the prior month it initially proposed 305p, then 315p, and then 325p. Sulzer also spoke to large institutional holders of
At the time there was speculation that Sulzer went after
Between mid-April and the expiration of a “put up or shut up” order from the Takeover Panel on April 27th, SUN SW increased its proposal to 332p and finally 344.5p (340p + 4.5p final dividend), both of which
After the deal broke,
Bodycote has often traded at a discount to the
There’s no obvious reason for the discount at which
I used the following comparable companies in looking at relative valuation:
The comps [and
The comps [and
BOY LN has a trailing EBITDA margin of 22.6% while the comps average EBITDA margins of 14.9%, for a 7.7% difference. BOY LN has an EBIT margin of 14.6% while the comps average 10.8%.
Summary:Bodycote is somewhat unusual in that it is in the
|Subject||Market ignoring value of Testi|
|Entry||11/14/2007 12:43 PM|
|I think it's clear the market is ignoring the testing side of Bodycote in valuing the company. I looked more closely at some European "Testing" comps and how they trade. |
Testing is 27% of Bodycote's business (by sales), and testing companies trade at much higher multiples than engineering companies, while the market gives Bodycote no credit for this part of its business.
Here are some testing comps:
Intertek - ITRK LN - £1.6bn market cap; does testing, inspection and certification in consumer goods, commercial & electrical, oil, chemcial and agri markets, and government services.
Inspicio - INP LN - £207mm market cap; does testing & inspection, environmental services, independent analytical testing, and consulting. On October 12th, INP LN confirmed it recently received approaches from interested parties which may lead to an offer.
SGS Group - SGSN VX - CHF 11.2bn market cap; a leading inspection, verification, testing and certification company.
Bureau Veritas - BVI FP - €4.5bn market cap; recently IPOd; does inspection & audit, testing & analystics and certification to a variety of industries and government.
Since INP LN is up due to bid approach, average multiples of these four are a bit higher than would be without the bid approach, but average mutiples still highlight premium at which testing/inspection companies trade:
EV/EBITDA - these comps trade at an average of 11x 2007 (vs 6.9x for all of BOY LN) and 9.4x 2008 (6.3x for BOY)
EV/EBIT - these comps trade at an average of 14.9x 2007 (vs 10.6x for all of BOY) and 11.9x 2008 (9.5x for BOY)
P/E - these comps trade at an average of 21x 2007 EPS (vs.13.2x for all of BOY) and 16.9x 2008 (11.9x for BOY)
The company's corporate broker (all UK companies have one) mentioned that BOY LN testing acquisitions are done at 6x - 8x EBIT (near the higher end of that range, but not above it). Testing comprises about 27% of total revenues, but BOY LN is ramping it up with the target of getting testing to comprise 50% of revenues.
Looking at the charts of the engineering comps versus these testing comps, it's clear that BOY LN trades more in line with the engineers (these have been weaker lately while testing comps much less so). Market is ignoring the testing side of BOY. Testing accounts for about £163mm of BOY LN TRAILING revenues. If BOY LN Testing were a standalone company, it would be smaller than INP LN, the smallest of the four above. Probably doesn't make sense to separate it at this point, but might make sense when it gets to 50% of sales if market hasn't recognized the value of this part of the business.
An eventual spinoff of the Testing business could be another value driving catalyst.