|Shares Out. (in M):||64||P/E||14.3x||13.2x|
|Market Cap (in $M):||2,397||P/FCF||15.4x||12.8x|
|Net Debt (in $M):||767||EBIT||285||303|
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Quick Investment Case
We think that the recent selloff in the stock has created an opportunity to slowly start building a position in the stock. We estimate that the company
generates about 45%-50% of its adjusted EBITDA from Russia and Ukraine – the recent selloff of ~20% from the highs is understandable given what
is happening, but we think it represents an opportunity for a patient investor. At the current valuation of 27.05/share as we write this (market cap
1.7bn EUR, enterprise value 2.3bn EUR including unfunded pension liability), we think that the market is saying that the company will earn a ROIC of
9.5%-10% forever. We think that is too pessimistic given that the over the cycle ROIC has been about 11% and we think that they can do at least this
or better going forward. If this proves to be the case then we see fair value of 34/share (+25%) based on our 2015 estimates, with pathway to upside
to 40/share (+45%) for those with a longer-term outlook.
Investment highlights supporting our upside case include:
ü High, relatively stable ROIC, comfortably in excess of WACC
ü Relatively inexpensive valuation (25%-40% discount to peers on P/E and EV/EBIT, depending on multiple used and year under consideration)
ü Reasonable cash generation (5y avg ~110m) with potential for FCF to be above 130m next year
ü Dominant market position in growing CIS driven by largest network and economies of scale and benefitting from strong pricing power, driving attractive
regional adj. EBITDA margin of >20%
ü Exposure to ongoing US housing recovery driven by ~27% exposure to US
ü Potential to continue to close the margin gap to peers as they continue to execute on the “WCM” cost saving plan, which has thus far been successful
and is easy to understand
ü Large family owner that has been in the business over 100 years and invests for the long run
As an upfront health warning, having been through the numbers, we think that there is some chance that when the interims are released on 17th
April, consensus may need to revisit growth and margin assumptions for 2014 and 2015 and the result will be downgrades to earnings of 5%-10%.
We would be using this as an opportunity to size the position larger. We could of course be wrong on this, but would suggest not having a position of
more than 50% of the full size before the interims.
Quick Market Overview
They are a global flooring company, selling products in over 100 countries with a fairly balanced geographical split (for 2013, 27% of sales EMEA, 27%
North America, 35% CIS % other, with the balance being the Sports Surfaces division selling products such as Astroturf and running tracks, where they
don’t give a geographic split).
The flooring market as a whole represented about 12.2bn square metres in 2012, according to the company – the product and regional splits are as
The green parts are segments where the company are present, red is where they aren’t active. The key one where they don’t play is ceramics, which is
supposedly much more competitive.
The popularity of various products varies a bit by region, we think most due to climate and cultural factors. As an example, ceramics don’t tend to retain
heat as well as, say, carpet, so in a colder country such as Russia, it would make less sense to have ceramic floors as your house will constantly be cold.
Within the areas of the market where they’re active, the overall market was about flat from 2010 to 2012, before recovering a bit in 2013. The growth has
varied quite meaningfully by region, as evidenced by the graphic below:
The graphic shows Western Europe declining slightly as the European malaise continued to impact their segments negatively, while the US enjoyed a strong
recovery and CIS and the Balkans continued to go great guns. The 2016 bar on the far right is the company’s estimate of how they think their addressable
market can grow from 2012-2016 – they have it growing 4% CAGR from 2012-2016. The moving parts behind that are:
Western Europe 0%
Middle East/Africa +5%
North America +5%
Asia Pacific +4%
It’s not shown in the chart above, but for the record the company reported organic growth of +3.3% in 2013, with the growth rate accelerating from +0.8%
in H113 to +5.4% in H213 as EMEA organic growth swung from -2.9% in H1 to +1.2% in H2.
Company Business & Positioning
They are one of the largest flooring companies globally, with a presence in most regions but not all products – their overall addressable market is only 29% of
the total market, with notable absences in ceramic (49% of the market) and residential carpet (22% of the market).
Their exposure is quite balanced, with the regional split given above. By product, they are 60% vinyl/lino (where they enjoy number 1 manufacturing
positions in France, Germany, Russia, Sweden, Ukraine, Kazakhstan and Belarus, and the number 2 position in the US), then very roughly 10% each in
carpet, wood/laminate and rubber, with another 10% in sports flooring.
They claim that about 80% of their exposure is to renovation, which is a bit less cyclical, and the other 20% is to new construction, which is obviously quite
cyclical. About 50% is residential, 50% commercial.
In terms of market positioning by region, in EMEA they’re a leader - they are mainly present in vinyl, where they estimate that they sell 25%-30% of all
flooring. They are also present in wood and laminate but less that 5% share everywhere except Scandinavia, where they are ~15%. Largest single
market is France at 25%; Scandinavia another 25%; Germany and UK the next largest; Spain and Italy then 8% combined. The outlook for this part of the
business is muted but probably slightly improving - has been flat to small down in the last couple of years. H213 was actually up 1.3% organic, so seems
to be recovering off easy comps. The company cite IMF reports of flat growth in 2013 and 2014 (think slightly upgraded since then) and a slight contraction
in the construction market, followed by 1%-2% growth in 2015. The company point to price rises from 2013-2016 and a pickup in volumes from 2015 as
potential top line drivers, but are not that optimistic. The main competitors are Forbo (who actually reported a robust set of results this week), Gerfloor,
KKU, Beaufloor, James Halstead in the UK, and Bauwork-Boen. There is secondary competition from the US companies Mohawk and Armstrong Flooring,
while there are also some local players market by market, though scale disadvantages tend to limit their involvement.
In North America we’d classify them as an also-ran – they’re 4th largest in commercial carpet after the acquisition of Tandus in 2012 for 272m EUR (0.95x
sales, 5.6x EBITDA). They don’t have any position in residential carpet, which is the biggest chunk of the market. They are the second-largest in vinyl/lino,
with a market share just below 20%. They expect significant growth in the market across all products as the recovery develops. They expect to take some
market share driven by innovations in resilient (particularly luxury vinyl tiles, which they have been working on). They reported 5.4% LFL growth in 2012
which slowed to 3.0% in 2013, though the growth rate picked up in H213 to 3.7% from 2.1% in H1. Key competitors are Mohawk, Shaw Floors, Armstrong
Flooring, Interface and Mannington.
CIS & Other is the part of the portfolio we’d classify as the jewel in the crown. 80% is Russia/Baltics, where they are the number one player with the best
brand recognition, largest distribution network and local production, as a result of 20 years of presence in this market. The quality of the business is evident
via a quick glance at the numbers, where they did organic growth of 10.2% in 2012 and 4.1% in 2013, while the EBITDA margin was an impressive 21.4%
in 2013 and 20.6% in 2012 against the group margin of 11%-12%. Prior to the situation in Ukraine, the expectation had been CAGR of ~3.5% in CIS economies
from 2012-2016. They think that the flooring market will grow faster than that given that about 2/3 of the "flooring stock" in Russian residential is former
Soviet bloc that is badly in need of renovation That represents a 2bn square feet opportunity. The further driver is that they are the best-positioned company
in Russia, as outlined above.
First a quick overview of the capital structure, historical performance and what we’re expecting:
First, the historical overview – the reported numbers in the snapshot above don’t tell the full story as there’s some structure and currency impacts hitting
the top line. The organic growth and the adjusted EBITDA margin profile is as follows:
Reporting segment splits weren’t available pre-2010 but the table shows that the organic growth got walloped in 2009 with the financial crisis -18%,
before bouncing back strongly in the following years, with a slight softening in 2013 as the economic situation stabilised a bit.
The margins have been around the 11%-12% range with the exception of 2011, where they dropped by a huge amount. That was related to raw
material prices – COGS are about 71%-75% of sales (depending on pricing pressures) – 45% of the raw materials are PVC (related to ethylene), 30%
plasticizers (naptha), 11% wood, 8% fibreglass. When the oil price squeezed from late 2010-2011, the company saw their raw material prices shoot
up. They can pass that on to their customers, but there’s a lag effect of 6-12 months, so you can see that they pretty much fully recovered the margin
by 2012, but there was a short-term impact.
From 2010-2010, the FCF was volatile but averaged 125m. There was then a disaster in 2011 when it pretty much evaporated. Two main drivers
there were the raw material impact described above knocking 45m off EBIT, and then as sales recovered in 2011, there was a WC outflow of 22m
to support that - 45m +22m = 67m which is most of the delta. 2012 was a great year with 145m FCF – again two main drivers:
1. Price increases implemented in H211 and H112 see sales up ~5% organically, o/w a big chunk price, which drives reported EBIT up ~70%.
2. Implementation of best practices (together with some one time benefits relating to inventory in last 2 months of the year) leads to WC inflows in 2012
despite sales up ~5% organic
The inventory impact then swung the other way again in 2013, but we think that the 105m of FCF they reported in 2013 is not that far off what was
a normalised number (maybe ~5m-10m higher).
Finally, the net loss in 2008 mainly relates to 60m of impairments they took on assets globally as the financial crisis played out, together with a 40m
loss on the sale of a US business, where the developments in US housing spooked them.
In terms of our expectations going forward, we’ll paste that summary again below in case it got lost in all the information above:
The key discussion points would be the sales, where we’re ~3% below consensus for next year, and the EBIT, where we’re 6% below this year, 11% next
year. We think most of the delta is driven by the top line – we set out our forecasts below and highlight some of the main points:
Really the key things to understand are Russia/CIS and, to a lesser extent, North America. CIS we have organic growth picking up to +12% this year from
+4.1% last year, but reported growth -1%. The delta from the organic to the reported is to do with currency – RUB is a large exposure for them and it will hurt
We think they faced a headwind of -9% in Q313 and -10% in Q413. This year, using current spot rates for the rest of the year, the headwinds by quarter
are -18%, -18%, -13%, -12%. How have they responded? In H213 they put through two price increases of 5% each, and from 1st April another 5% price
increase goes through in Russia. The market had been concerned about this going into the FY numbers but the management had argued that price elasticity
of demand is in fact quite low as flooring is an infrequent purchase and given most of the Russian market is consumer rather than into wholesalers, people
tend not to be aware what the price was a month ago, a quarter ago, etc. There proved to be some validity to this argument as organic growth in CIS proved
resilient in H213 vs. H113.
In terms of justifying our +12% organic in 2014, we think price gets them at least 7.5% and probably nearer to 10% - it will be 10% at least in H1 and
they get partial benefit from the additional 5% that goes through from the start of Q214, so it is probably nearer to 12.5%. In H214 they get all of the
benefit from the 5% hike in Q214 plus some of the benefits from the hikes over H213, so it is probably about 7.5% on average. Volume will be harder to guage
- consensus has 2% GDP growth in 2014 but that has been falling (MS d/g from 2.7% to 0.8% today). There will potentially be some volume impact from
the price hikes but management say it is quite minimal for the reasons described above. I think 10% price, then Russian GDP of 0% +2% add on for the
fact that they tend to grow faster than the market and not all of the division is Russia is reasonable.
When you then factor in the currency impact above, that gets you to the reported -1% we are going for.
In terms of the margin dropping 100bps – the dynamics are as follows: in H113 they lost EUR 9.4m on top line via RUB move (RUB -3% approx) - but they
then made back 5.3m on the cost side as they have localised production - so net impact in H1 on EBIT from a 3% depreciation was -4.1m. The company then
state on slide 8 of FY13 presentation that the FY impact on EBITDA was -15.5m i.e. -10.4m in H2. RUB depreciated about 9% in H2 - based on the H1 experience
they should have lost around 12.3m, so price increases have helped. H114 impact should be -18% on RUB, and then -12% in H214, so I think worst case would
be -24m on EBIT in H114 and then about -15m in H214 However, there were 10% price increases in H213 and another 5% goes through from April 2014 - a
total of 15% price increases should ensure the impact on EBIT is not 39m EUR for the FY. If you assume that ~75% of "CIS & Other" is Russia, then it would be
665m EUR sales and hence assuming the incremental margin on a unit of price is 100%, they would need prices ~6% higher on average across 2014 to recover
the currency depreciation thus far. Obviously there would be a negative volume impact as well. The CIS margin in H213 was 23.3%, +280bps YoY - for the FY it
was 21.4% - the language at the roadshow post FY13 was that they don't want to go much above 20% to avoid attracting competition - strikes us as reasonable
to model ~100bps margin contraction for 2014.
The other topic of discussion is the US growth, where we have 4% organic, 2% reported – this is actually one area where we fear the sell side may be missing
something - USD is also a bit of a headwind in H114 - in H213 they had a headwind of about -5% but it got lost in the structure effects of the big acquisition.
They reported 3.7% organic growth in H213 in the US - that is perhaps about as good as they can hope for, so we think they report flat to slightly negative
overall growth in the US in H114 and then low to mid single in H214. The margin we have small up as they are reporting some organic growth through pricing,
which should give them some incremental margin benefit.
So all in all we’ve got sales a bit below consensus and then margin improving slightly in 2014 and 2015. The margin recovery we think is reasonable to assume
for a number of reasons:
1. They’ll be reporting organic growth we think, some of which through pricing which should carry attractive margins
2. They are currently restructuring some businesses and implementing best practices. The most high profile restructuring is relocating some manufacturing
of wood products (which incidentally we think is a poor business) from Northern Europe to lower-cost Eastern Europe. Salaries would be lower and the product
will also be closer to end markets so there should be logistical savings where the visibility is relatively okay. On the best practices side, again it is quite visible,
simple and has been successful so far. They have 30 manufacturing sites globally and the plan is based around implementing best practices across the individual
factories using a team of 22 dedicated people, while also centralising the purchase of raw materials to get the best terms. It has been successful so far and the
company have guided that there can be more to come:
3. Finally, there is still a meaningful gap on margins between the company and the peer group, which might support the argument that margins haven’t yet
reached a ceiling (see highlighted yellow cells):
In terms of valuing the business, our two key approaches in order of preference were fair EV/IC based upon the ROIC, followed by a DCF. The DCF is
less-preferred as, despite what the company claims on the stability of the business, we think there is still a reasonable amount of cyclicality in the business,
hence our confidence in the out year estimates is low.
The numbers that we estimate are as follows:
The operating income forecasts are derived as described above – the difference in the ROIC per our definition and the company definition (i.e. we have 11.6%
in 2015, the number based on the company definition would be 18.3%) is mainly related to the fact that the company looks at it pre-tax (go figure – the last
time we checked, we couldn’t go back and claim our share of the tax paid back from the taxman) and the fact that a few small items the company don’t classify
as invested capital do count according to us.
Looking out to 2015, we think they generate ROIC of 11.6% - our estimate of WACC is 7.6% (calculations are in the DCF after this) and think growth is ~3% -
for that profile, we’d pay ~1.9x invested capital, which implies equity value of 32.5 in 2015, plus you clip about 1.5 of dividends between now and then.
With the usual health warnings around DCFs on cyclical companies, FWIW we are arriving at around 22% upside – for the sake of completeness, forecasts
are as follows:
Which derives the following value:
If you think our growth rates are too high/WACC too low, sensitivities are as follows:
Just to sanity check we also did some valuation estimates based on peer multiples and target FCF yields, with the following results:
As noted above, we think you start to accumulate a small position now, there is some risk of a reset of guidance on 17th April and stock -10% or so, and
you can then use that to build the position at an inexpensive valuation for a patient investor.
Risk here is clearly around KKR, who hold a lot of stock and could potentially be sellers (we have no insight here on timing) – again, would see that as an
What Can Go Wrong?
1. We think that consensus estimates for revenues for 2014 might be too high due to the currency moves of late - Russian moves are probably front and
centre but does not seem to be reflected in consensus. USD might surprise people a bit as well?
2. We are a bit below consensus on net income for 2014 and 2015 so need to go back and check the numbers - downgrades?
3. We think from the numbers we have estimated and what I have looked at for the peers that the earnings momentum is potentially a bit better in some
of the other names which could act as a headwind to any rerating
4. Russia/Ukraine situation is probably a source of negative sentiment and might scupper any rerating
5. Potential placing by KKR
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