Value Investors Club / Elanders AB (ELANB:SS)

Description

Elanders AB is an interesting long investment opportunity with ca. 100% upside in 5 years from the current share price

of SEK 83.

The essence of the investment is based on an ongoing company transformation:

a) From a printing company – an industry in structural decline

b) To a high value-added contract logistics company – industry in structural growth as customer outsource

some of these low value-added functions to logistic suppliers

Elanders’ profitability has been affected this year by set-up costs on new contract wins in its logistic business. These

problems are short-lived. Nevertheless the share price is down 30% since the peak in July 2017 at SEK 117. This

share price weakness has opened the window to invest in Elanders.

Elanders is a Swedish company – thus reports in Swedish Krones (SEK). To convert to € / US-$ divide by 10 / 9 resp.

Background/History

Elanders was founded in 1908 in Sweden to print the first Swedish National Directory for Swedish telecom

company Royal Board.

The company remained a small Swedish company focused in printing until 1980 when they decided to

internationalized. From 1980 to 2014 it internationalized through a series of acquisitions. In this roll-up any equity

issuance was underpinned by Carl Bennett who in 1997 took a 50% in the company. Carl Bennett is one of the

richest people in Sweden with a net worth of ca. $ 2,5bn – first generation. His most famous and profitable investment

was Getinge – which he acquired from Gettinge in 1989. Getinge has a market cap of SEK 34bn and Carl owns 16%

of it.

In January 2014 Elanders acquired Mento Media – a Singaporean company specialized in contract logistics. This

acquisition was the beginning of Elanders transformation from a printing company to a logistic company.

In June 2016 Elanders made progress in this transformation by acquiring German logistic company LGI.

Business Overview

A. Elanders as a Glance

Following the acquisition of LGI the Pro-Forma revenues and profitability mix looks as follows:

Business	Revenues	% of Revenues	Cash Earnings	Cash earnings margin	% Cash earnings
Contract logistics	6059	73%	436	7.2%	68%
Printing/packaging	1992	24%	176	8.8%	27%
E-commerce	249	3%	30	12.0%	5%
Total	8300	100%	642	7.7%	100%
Group overheads			-60
Total after corporate overheads	8300		582	7.0%

I defined Cash Earnings as EBITDA as reported minus total capex because:

- In Contract Logistics there is approx. SEK 58m of PPA from the acquisitions of Mentor Media and LGI

- In Printing/Packaging capex is below D&A (this is now typical in companies exposed to the decline in print – e.g. look at newspaper businesses) . Over the 2011-2016 period Elanders capex in this division was roughly 60% of D&A.

Business Revenues

The main point from this overview is that Elanders has made huge progress in transforming the company – back

in 2013 printing accounted for nearly all the business. The investment thesis on Elanders hinges on the contract

logistics business – so I will only discuss this business in this write-up.

B. Contract Logistics

1. Context

Contract logistics is a broad industry with activities ranging:

- From low value-added (let’s call it “freight” business). This business is largely commoditized and margins are

razor-thin (1-2% EBIT margin). In this business they way to make money is through economies of scale and

cost discipline. Danish company DSV would be one of the best in this sub-sector within contract logistics.

- To more “sophisticated” logistics work. This is a much better business as there is more “co-operation”

between supplier/customer (as we shall see in the examples) and longer contractual terms. This high value-

added work results in higher margins of 6-7%.

Elanders focuses on more sophisticated contract logistics work.

2. Examples

I think the best way to understand what sophisticated contract logistic is logistics is through a couple of examples.

2.1 Example 1: Automotive - Just-In-Sequence Delivery for a German car OEM

LGI (now part of Elanders) is the warehouse for some components/parts used by this car OEM in one of their car

manufacturing plants. This is how it works:

- The customer (car OEM) orders some parts they need to manufacture a car to LGI via an IT interface. LGI

takes ca. 900 orders per day on average from this car OEM.

- LGI is responsible for sourcing the parts from a network of 25 suppliers (approved by the OEM), having the

right stock level (this inventory sits on LGI’s balance sheet).

- After LGI receives the order LGI will pick up the parts from its warehouse, package them in a box and

transport the parts to the adequate points of the car assembly line within very short lead-times (measured in

minutes). LGI does roughly 15.000 picks per day implying 16 items per box on average.

Magnus claimed that because of LGI the car OEM was able to reduce warehousing and fulfillment costs.

These contracts are re-tendered every 3-5 years. This is much better than tenders in the freight business which are

annually or half yearly – thus eliminating any room to capture efficiency gains.

In terms of financials Magnus told us that in this type of projects LGI makes 6-7% operating margin. This is

remarkable as (at first sight) the business appears to be a pure execution business with low barriers to

entry/competitive advantage.

2.2 Example 2: Health Care – Agilent Technologies

Agilent is a US-medtech company specialized in liquid chromatography machines (e.g. used for separating molecules

that are dissolved in a liquid).

Agilent has outsourced the inventory management globally. Elanders has been selected as the partner for Europe; 2

other companies cover Agilent’s US and Asia Pacific operations. For Aligent’s European operations Elanders is

responsible for the whole order management process: order taking/processing, control of inventory, fulfillment and

installation, returns, track & trace…

We did not ask for any success metrics or value-added to Agilent. In Elanders’ website they have posted the following

quote from Agilent: “we have increased the utilization of all [rented] devices by more than 30% while spending much

less time on the process.”

Profitability (EBIT margin) in this type of contracts range from 5 – 10%.

3. Segmentation Overview

The most relevant way to segment Elanders contract logistics division is by the value-added of their work. For the

2016 pro-forma the revenues and profits looked as follows:

Value-Added	Group	Mentor Media	LGI	EBIT margin
High	67%	100%	50%	6-9%
Low ("Freight")	33%	0%	50%	1-3%
Total %	100%	100%	100%
Total SEKm	6000	2000	4000	6-7%

Here is lies the opportunity. As you can see LGI still has nearly half of their business in the low value-added/less

profitable activities of contract logistics. Magnus and Andreas plan and strategy for LGI is to increase the weight of

higher value-added projects (like the one described above). This will mechanically lead to a margin expansion in this

business.

4. Acquisition of LGI

4.1 Rationale

Elanders acquired LGI for 2 reasons:

a) Grow the top line: with the LGI acquisition Elanders has a very good opportunity to leverage customers and

skills across regions:

- LGI has given Elanders ex-LGI a stronger presence in Europe. Before the LGI acquisition Elanders

used to struggle to win additional business from existing customers in Europe. For information >90% of

the revenues from Mentor Media come from Singapore and China.

For example a customer (e.g. car OEM) would happily give Elanders a printing-related business but

rarely something on contract logistics before the LGI acquisition.

- There is an opportunity for Elanders to grow LGI outside Germany, which accounts for ca. 70% of

LGI’s revenues. Magnus said that LGI’s owners (private equity) had a strong regional focus on

Germany.

Magnus told us that they negotiations are ongoing for new projects in Europe - lead-times for the

sophisticated projects aforementioned can take 1-2 years.

b) Secondly Elanders can improve the profitability of LGI by increasing their focus on higher value-added

contract logistics. As mentioned in the sub-segmentation chapter the share of low value-added logistics is

high (50% of revenues) at LGI.

We should not expect any meaningful cost synergies. LGI had strong cost consciousness under PE

ownership. Andreas said: “people at LGI measured everything: each customer, each location…”. “LGI was

run through numbers”

4.2 Acquisition Process

The acquisition process of LGI was the worst of what you can follow as a buyer:

- The deal was managed by the investment bank Rothschild through a systematic process

- 3-4 bidders made to the final round, including Asian players.

- Magnus suspects that the competitive bids were higher than Elanders’. Nevertheless Elanders got the deal.

In the last round Elanders demanded exclusivity in exchange for a firm payment commitment within a week.

These are the benefits of having a billionaire as Chairman and largest shareholder.

4.3 Price Paid

Elanders acquired in June 2016 LGI for € 261m – including € 4m of advisory costs and costs related to the rights

issue of SEK 700m.

In FY 2015 LGI reported revenues of € 430m and adjusted EBITDA of € 33m (€ 4m of non-recurring costs related to

restructuring costs). Thus Elanders paid 7,9x 2015 EBITDA.

At the time of the acquisition Elanders expected LGI to generate EBITA of € 24/25m, up from € 21m in 2015. Thus

Elanders paid nearly 12,5x on 2015A EBIT and 11x EBIT on 2016E.

In any case this is a high price. Magnus admitted so: “we paid too much in the end, relative to what we normally

paid”.

5. Competition and Competitive Advantages

The contract logistics industry is very fragmented. Xerfi (a French market research company) did a study in 2015

about the contract logistic market in each country.

Country Market Size No. 1 No. 2

- France € 11,1bn Arvato (.. .share) ID Logistic (5,2% share)

- Germany € 9,0bn Arvator (…share)

This provides opportunities for consolidation – and growth via acquisitions.

In low value-added there are no competitive advantages – it is perceived as a commodity, with tons of competition,

totally price driven.

In the more sophisticated projects price is not as important. What matters most for the customer is the track record of

the supplier. The customer outsources a C-function - if the logistics supplier fails, then it will have a significant impact

for the customer’s top line.

Secondly as mentioned above there is some co-operation between the logistic partner and the customer (e.g. like the

IT interface between Elanders/car OEM to process the order flow). This co-operation mean that switching costs are

somehow higher than in the low value-added project.

Long-Term Financial Goals

The company has 2 financial goals for the long-term:

a) Annual revenue growth of 10% per year for the group, of which more than half will come organically. Given

the level of debt (net debt was SEK 2,6bn or 5x annualized Q3 2017 EBITDA) I think most of the growth will

come organically. In Q3 2017 organic revenue growth of the group was 10% yoy.

b) EBIT margin of 7%. If we add the SEK 60m of PPA amortization, and some of the D&A back (as capex <

D&A) we get to a cash earnings margin of > 8%. The P&L for 2016 pro-forma (leaving the profitability of

printing and e-commerce businesses unchanged) would look as follows:

Revenues Cash Earnings Cash Earnings Margin

- Contract logistics 6059 518 8,5%

- Printing 1992 176 8,8%

- E-Commerce 249 30 12,0%

- Overheads -60

- Total 8300 664 8,0%

Management and Governance Discussion

As mentioned above Carl Bennett is Elanders largest shareholder (50%) and Chairman. Given his track record at

Getinge this is very positive. Two traits underpinned Elanders culture positively:

a) Long-term perspective: we met Magnus Nilsson (CEO) and Andreas (Wikner). From our discussion it was

obvious that they do not care about quarterly earnings. Instead their focus is on growing the value of the

company over the long-run.

b) Ambition: since 2013 Elanders has increased its revenues by 4x through the 2 large acquisitions

aforementioned. On its own/isolation this would be bad – a lot of capital has been destroyed by empired-

building CEOs. However our impression is this is not the case in Elanders for two reasons:

- Firstly in contract logistics (particularly on the high value-added) there is some aspects of size. Elanders

deals with large customers (e.g. German car OEMs) managing C-functions for them. If you are a small

logistic supplier it would be very improbable to get those contracts.

- Secondly Magnus’ strategy is to focus on high value-added logistics. They are not much interested in

what they refer as “freight” logistics - this a poorer businesses: largely commoditized, low value-added

for customers, very high level of competition and in the end razor thin margins.

So Marcus is prepared to say no or to cancel existing (in LGI) projects of low value-added. Overall we found Marcus and Andreas very solid managers, well aligned with culural traits.

Valuation and Returns

1. EV/Sustainable EBIT 2016 Pro-Forma

With the share price of SEK 83 Elanders has a market cap of SEK 2.934m. Net financial debt is SEK 2.597m and

pension liability is SEK 86m . Thus Elanders has an EV of SEK 5,6bn.

With sustainable EBIT of SEK 664m – then Elanders is trading at 8,5x sustainable EBIT with revenues of 2016 Pro-

Forma.

2. Total Shareholder Return

I assume that Elanders is able to grow revenues at 5% per year organically and cash earnings margins will expand

from 7% to 8% by 2021. Then by 2021 Elanders will have revenues of SEK 10,1bn and cash earnings of SEK 807m.

The net financial debt is expected to decline by about SEK 1,2bn to ca. SEK 1,3bn.

Thus if I were to value Elanders at 10x 2021E EBIT of SEK 8077m given that level of debt, I would get to an imply

value of the equity of SEK 6,8bn (or 192 per share with the share count unchanged at 35m).

This would imply an upside (undiscounted) of 130% vs. the current share price of SEK 83.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Catalyst is improvement of margins as ramp up of revenues reduces the impact of set-up costs in new contract logistics projects

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			2017	2018
Price:	83.00	EPS	0	0
Shares Out. (in M):	35	P/E	0	0
Market Cap (in $M):	345	P/FCF	0	0
Net Debt (in $M):	306	EBIT	0	0
TEV (in $M):	651	TEV/EBIT	0	0