If you agree that sticking with boring and cheap is the recipe for good long-term performance you do not want to miss Washtec AG (WSU) - an unglamorous yet steady carwash equipment manufacturer whose shares are selling for 7X NFY FCF and sporting a 4.5% NFY dividend yield.
Washtec AG is the largest European manufacturer of car wash equipment with a 40% share of the highly consolidated market; in addition, the company provides carwash maintenance services to its customers. On average, the equipment side of the business contributes about 2/3 of WSU's sales and about 1/3 of profits, with the rest coming from the parts & service side of the business. WSU's business boasts a degree of stability over time thanks to its parts & service division - carwash operators generally do not have an option of deferring maintenance, as that would generally mean carwash stoppage and related significant cost overruns.
Due to WSU's industry-leading position, the relatively stable nature of the underlying business, and depressed valuation, the Company's stock represents an attractive investment opportunity as evidenced by:
- WSU's leading position in the European carwash equipment manufacturing and maintenance, which enables the company to generate 15%+ returns on equity;
- Solid financial condition, as WSU enjoys a debt payback (Net Debt/FCF) of less than two years;
- Cheap valuation, as WSU's stock is selling for approximately 7X NFY FCF and sporting a 4.5% NFY dividend yield.
THE BUSINESS AND ITS COMPETITIVE ADVANTAGES
Carwash equipment manufacturing is a business, in which industry leaders such as WSU, enjoy solid profitability over time. As carwash operators' profitability is directly impacted by their choice of the equipment manufacturer (who is also generally going to be the maintenance provider), the operators have an incentive to stick with reputable vendors. Purchasing an inferior piece of equipment today means a higher cost down the road due to lower productivity, higher downtime, and more maintenance. In addition, due to a high degree of carwash equipment complexity the operators are generally forced to rely on the vendors whose equipment they purchased to provide maintenance services, thus putting the vendor in a superior bargaining position when it comes to aftermarket servicing. Therefore, those manufacturers who lack well-developed service networks become less attractive partners for carwash operators, as dealing with them runs up operators' downtime. Further, delaying carwash maintenance is generally not an option either because it may cause carwash stoppage and related cost overruns or because of the liability risk related to potentially damaging customers' vehicles. As a result of the dynamics described above, the owners of the most reputable brands and of the most extensive service networks, can, in most cases, charge a decent mark-up vs. competing products, while enjoying a stable demand for their parts & services (which are generally the biggest profit contributors). The ability to extract a premium for a better-reputed product and a better-developed service support network is a major factor that helps ensure the leader's dominance by keeping rivals at bay.
The aforesaid economics of the car wash manufacturing industry imply that WSU's major competitive advantages are the strength of the Company's brand name and the Company's extensive service network.
As WSU name stands for high-quality products supported by the largest service network, car wash operators are normally inclined to purchase from the Company despite a 5-15% premium vs. secondary brands. Due to the long product lifecycle (10 years or more), it makes more economic sense for the operator to pay a small premium for a reliable piece of equipment supported by a well-developed service network, and then enjoy a long period of superior productivity, less downtime, and lower vehicle damage expense - which in aggregate more than offset the premium.
It would be fairly hard for the rivals to replicate WSU's brand name and service network advantage given their much smaller size and the lack of financial strength. As such WSU's competitors simply do not have the resources to match the company's lead in quality, new product development capabilities, and its pan-European 24/7 service network.
In addition there are a couple of smaller advantages of scale that WSU enjoys. First, having the largest volume in the industry enables WSU to have substantial purchasing efficiencies, thereby lowering its cost structure vs. the competitors. Second, scale enables WSU to offer a broad array of products and services to its customers, thus enabling them to become more efficient by cutting back on the number of suppliers, therefore making WSU a more attractive vendor to them.
The above advantages enable WSU to generate solid returns on equity of 15%+ over time, while employing a reasonable amount of debt (the company could pay off all of its debt in less than two years from its cash flow).
There are a few potential negatives one has to be aware of:
- Relatively high customer concentration. In its European business WSU faces a high degree of customer concentration, as most car washes in Europe are operated by major oil companies. This makes it harder to pass through cost increases, and therefore, WSU has to constantly strive to rely more of finding efficiencies as opposed to simply raising prices for its products to preserve margins. Nevertheless, WSU has a long history (15+ years) of being able to maintain its margins at a fairly constant level despite constant pressure from Big Oil Cos. in Europe;
- Little growth potential. Car wash equipment manufacturing is a slow-growing, mature, and highly-consolidated industry. Therefore, it is unlikely that WSU will exhibit high growth rates in the future. However, as long as the price paid for the business is low enough, as it currently is, in my opinion, the slow-growth nature of the business shouldn't derail the investment case;
- Management. While current management proved to be astute operators, who engineered an impressive turnaround in the mid-2000s after the previous management team nearly destroyed WSU, their track record on the capital allocation front is mixed. While management returned some cash to the shareholders via share repurchases and dividends, they also invested the North American business expansion, which has not proven very successful so far. However, with major shareholders having more say with respect to capital allocation as a result of last year's board addition, it is reasonable to assume that dividends and repurchases will start taking precedence over expansionary investments going forward.
In WSU's case valuation is relatively straightforward. The calculation of the Company's NFY FCF is presented in the table below:
At $8.75 WSU's market cap is approximately $122 million, resulting in NFY FCF multiple of approximately 7X. Given the quality of the Company's business, it appears that the stock is significantly undervalued at current levels.
- Sheer cheapness of the stock that trades at a significant discount to its intrinsic value