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KSB - Significantly Undervalued Mid-Cap from Germany

January 27, 2012 | About:
Chandan Dubey

Chandan Dubey

97 followers
1 The company: KSB has a global market share of 10 percent of the world's largest manufacturers of pumps, valves and related systems, headquartered in Frankenthal (Pfalz). The Group has its own sales companies, production sites and service companies and is represented on all continents. Approximately 80% of the ordinary shares are in the hands of a foundation; the remaining ordinary shares as well as the preference shares are freely floating shares.

KSB manufactures its products on all five continents. With production sites in 19 countries and a

tightly knit sales and service network, KSB employees are always close at hand when customers

have fluids to transport or flow to shut off. KSB sees the geographical diversity as one of the key factors as to why it was able to generate good results even during the economic downturn.

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1.1 Products

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1.2 Key figures
No. of shares1,751,327
No. of ordinary shares/price (KSB.F)886 615/€443
No. of preference shares/price (KSB3.F)864,712/€400
Market cap€744 million (Jan 26, 2011)
Total liabilities€1,058,858,000 (June 30, 2011)
Cash and equivalents€301,926,000 (June 30, 2011)
Equity€818,461,000 (June 30, 2011)
Enterprise value€1,500,932,000 (€1.5 billion)


1.3 Shares

  • The share capital totals € 44.8 million and is divided into 1,751,327 no-par-value shares (ordinary and preference shares).
  • The number of ordinary shares amounts to 886,615 (equals € 22.7 m of share capital); the number of preference shares amounts to 864,712 (equals € 22.1 m of share capital).
  • Approximately 80% of the ordinary shares are in the hands of Klein Pumpen GmbH, whose holdings are controlled by the KSB Foundation, the remaining ordinary shares as well as the preference shares are freely floating shares.


Each ordinary share authorizes the holder to one vote at KSB AG’s Annual General Meeting. Klein Pumpen GmbH, Frankenthal, holds approximately 80% of the ordinary shares; the KSB Stiftung (KSB Foundation), Stuttgart, holds the majority of the shares of Klein Pumpen GmbH. The preference shares carry separate cumulative preferred dividend rights and progressive additional dividend rights. Holders of preference shares are entitled to voting rights in the cases prescribed by law. The issue of additional ordinary shares does not require the consent of the preference shareholders. Similarly, the issue of additional preference shares does not require the consent of the preference shareholders unless the subscription rights exclude newly issued senior or pari passu preference shares.

1.4 Shareholder Returns

KSB has generated fabulous return for its shareholders. Around June 2004 it was selling for 100 and now around 400. Even without dividends this is a compounded 20% return over seven years. Furthermore, the dividend is not too shabby either. Here is the rundown of the dividends on ordinary and preference shares.

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KSB ordinary share

2010200920082007200620052004
Dividend per share in €12.0012.0012.509.002.001.031.03
Percentage of dividend yield (based on year-end share price)1.92.93.52.00.50.81


KSB preference share

20102009200820072006
Dividend per share in €12.2612.2612.769.262.52
Percentage of dividend yield (based on year-end share price)2.13.14.32.10.7


2 Sales analysis and growth

KSB manufactures its products on all five continents. With production sites in 19 countries and a tightly knit sales and service network, KSB employees are always close at hand when customers have fluids to transport or flow to shut off. KSB sees its ubiquity as one of the strengths of the company and is investing substantial amount of money in updating and opening new facilities, especially in China and India.

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KSB supplies its products to many different regions and sectors. This helps it in balancing out the opportunities and risks in various sales areas.

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KSB has been a consistent grower. Sales have grown at a compounded rate of 6.5% since 1999 and are now touching the €2 billion mark. It has been able to maintain its sales during the worst of the crisis and expects to see growth in this area.

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3 Management

3.1 Pay

The total remuneration of members of the Supervisory Board amounts to € 1,310 thousand for financial year 2010 (previous year: € 1,257 thousand), and the total remuneration of the Board of Management amounts to € 4,027 thousand (previous year: € 3,705 thousand). € 19,580 thousand (previous year: € 21,026 thousand) has been provided for pension obligations to former members of the Board of Management and their surviving dependants; total benefits paid to these persons amounted to € 1,436 thousand in the year under review (previous year: € 1,428 thousand). Additions of € 1,770 thousand (previous year: € 1,906 thousand) were made to the pension provisions for active and former members of the Board of Management. Based on the relevant legal provisions, the Annual General Meeting on 19 May 2010 resolved not to disclose the remuneration of the Board of Management separately for each member and classified by components.

The management does not seems to be excessive. The management board consists of 4 members and as KSB does not disclose their pay on a per person basis, we can't say how much each one got. But 1 million on an average is not overpayment.

3.2 Performance

How do you judge a management team. There are two things one can do. One, to look at the cold hard numbers from the company’s financial statements and second to look at the share-holder letters and see if they have delivered on their promises and has the company been taking the directions they want it to take.

The cold hard numbers are given in the following two figures. We see that KSB has done quite well with its invested capital. The RoIC has been between 8.9-16.1 with an average of 11.84. It has good FCF which has not been very consistent because of the cyclicity of its industry and the recent economic downturn. Furthermore, the capex (see in the valuation section) has been uneven. Still, it had one one negative FCF in the last 8 years and the company is fundamentally undervalued on this metric.

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Now, let us look at the shareholder letters and see if the management has delivered on its promises.

“We see the BRIC countries, i.e. Brazil, Russia, India and China, among the most important growth regions of the future. In the last five years, we have done a lot in these countries to build on our market position. Once the financial and economic crisis has subsided, we expect a return to strong, above-average demand in these countries. And we are ideally prepared to make the most of this for new business.” — Chairman

2007 We chose the boom markets of China and India as the first in which to extend our technical capacity. Last October, we opened a large valves plant in the Dalian special economic zone; this was followed a month later by our new manufacturing site for standard pumps in Shanghai. In India we were able to create additional capacity through alterations to the existing production technology. The result is a 25 percent rise in valve output. As well as this, we now have plans in place for additions to our Indian pump and valve manufacturing facilities. This year we are also investing in what continues to be our major market: Europe. Key elements of the investment programme are new production and test centres for large power station and water pumps, together with the expansion of our industrial pump production. We are committing € 70 million to these measures in Frankenthal, Pegnitz and Halle (Germany), and are also investing in butterfly valve production at La Roche-Chalais in France.

Our goal for 2008 and beyond is profitable growth for the KSB Group. Based on the positive developments hitherto, we aim for our sales revenue to pass the two billion euro mark by 2010. By then at the latest, our goal is also to achieve an eight per cent return on sales. -- they achieved the 2B mark in 2009 and the return on sales was 10% in 2008.

2008 In our ongoing strategy review process, we see our broad positioning in terms of market and technology as a competitive advantage. We shall not give up this advantage for the purpose of short-term profit maximisation. Instead, the different economic cycles of our market sectors always provide for a certain balance, creating an element of stability and supporting our sustainable profitable growth (even with the global downturn 2009 was the second best year at KSB in terms of sales revenue and profits, see below).

4 Financial strength

KSB has an enviable balance sheet. It has enough current assets to pay all its liabilities. It has no goodwill and intangible assets are only €90.5 million compared to €818.5 million in equity. The following data is from KSB’s most recent half year report:

Items (in € thousands)30 June, 2011
Cash and equivalents301,926
Intangible assets90,536
Current assets1,319,251
Total assets1,877,319
Equity818,461
Non-current liability468,437
Current liability590,421
Total liability1,058,858


Historically, we see in the figure below that KSB has been incrementally improving its balance sheet. Since 2006, the equity ratio, current assets, fixed assets, and the balance sheet total have all improved. Because of these numbers I put KSB in a low risk in terms of financial strength.

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5 Profitability

KSB’s margins have not been very stable in the last five years. But two things remain clear, the margins have improved in the last decade and also since 2008, the margins are on a decline. The management blames it on the global economic downturn. Let us try to put the income statement of 2008 and 2010 together and see where the margin suffered.

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ItemDec 31, 2008Dec 31, 2010
Sales1,991,7391,939,254
Other operating income31,24735,921
Cost of materials– 843,439– 790,855
Staff costs– 614,628– 649,844
Depreciation and amortisation expense– 35,017– 48,148
Other operating expenses– 336,765– 339,507
Other taxes– 7,973– 8,304
Financial loss– 7,229– 17,252
Earnings before income taxes200,117135,796
Tax30.2%33.75%
Earnings after income taxes139,48989,960


As we see, the margins suffered due to multiple factors. Higher taxes, higher labour costs, higher depreciation and amortization and a higher financial loss. As KSB has already made significant investments in its facilities, the margins will recover when it increases its topline (the cost of material as a % of sales has decreased since 2008).

6 Valuation

KSB has been a consistent generator of FCF. Below is a table of the company during 2003-2010.

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6.1 Discounted cash flow valuation

KSB had a negative free cash flow in only 2003 and since then has performed reasonably well. The FCF generation is far from stable. We see that the numbers are not very consistent, this is due to the cyclical nature of the company and the intermittent nature of its capital expenditure. If we look at the cash flow figures, they seem consistent enough, with a minor blip in 2010. With a 90 million starting FCF, 10% hurdle rate and no growth the company will be worth € 990 million. This is a potential upside of 34%, assuming no growth in FCF.

6.2 Valuation using net margin and P/E

KSB is a growth company. It has increased its sales from € 1,087 million (1999) to € 1,939 million (2010). This is a compounded growth rate of 6.5%. The company has enviable position in both China and India and is capitalizing on the growth opportunities there. With current revenue of 2 billion and market cap of 738 million, and a reasonable P/E of 12, the market expects a net margin of 3% at the moment. During the last decade the net margin has bottomed at 1.15% in 2004 and topped at 7% in 2009, the company is trading below mid-way of the margin spectrum. The potential upside is 233% and the potential downside is 62% (if the margin falls back to 1.15 and the market pays the same P/E).

7 Competition

We first look at the competitors and then make the case as to why KSB is a good opportunity. The competitors are

Dover Corp

Dover is an industrial conglomerate consisting of nearly 40 separate businesses. The firm organizes its business under four reporting segments: industrial products (26% of sales), engineered systems (31%), fluid management (23%), and electronic technologies (20%).

Crane Co.

Stamford, Conn.-based Crane is a manufacturer of highly engineered industrial products. Crane operates in five business segments: aerospace and electronics, engineered materials, merchandising systems, fluid handling, and controls.

Mueller Water Products

Mueller Water products designs, manufactures, and distributes water infrastructure components for use in drinking and wastewater markets. The firm reports under three business segments: Mueller Water, U.S. Pipe, and Anvil.

Following is the table of the key statistics and the companies relative valuations.

ItemDover (DOV)Mueller Water (MWA)Crane Co (CR)KSB
P/E14.1-159.68
P/S1.50.31.20.38
Rev growth (3Y avg.)-0.4-10.4-5.42.5
EPS growth (3Y avg.)4.3--0.3
Op Margin14.70.5%11.6%7.7%
Net Margin9.9-2.9%7.7%3.9%
ROE17.6%-9.7%18.9%9.8%
Debt/Equity0.51.70.41.1
EV$14.8 billion$1,470 million$3.5 billion€1.5 billion
FCF (2010)$764 million$30 million$104 million€89 million
EV/FCF19.34933.6516.85


It is not difficult to make an investment decision here. MWA and CR are quite expensive. Dover and KSB are close in terms of valuation, but KSB’s margins are at a low and Dover’s are on a high. One a purely valuation basis, KSB is a better bet.

8 Risks

Apart from the normal risks like foreign exchange risks, competitive risk which are there for every company, we want to discuss the liquidity risk and the risk of global downturn.



The following table describes the amounts/liabilities KSB has according to their maturity. With €301 million in cash, I don’t see KSB having any problems fulfilling its financial covenants.

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Another risk to consider is the global downturn. We want to ask as to what is the minimum cost KSB must pay to run its operations. Currently, KSB pays €650 million in staff costs and €50 million in amortization and depreciation and another €339 million in operating expenses such a leases, currency translation losses, assets disposal losses administrative expenses etc. So, for KSB to remain above water, it needs to sell €1,039 million. This is half of its current sales and seems pretty unlikely even in a downturn.

Investment thesis

  • KSB is both geographically as well as industrially diverse company. It has operations on all major continents and is expanding in China, India and Latin America. A large part of its sales (>20%) already come from this region.
  • KSB has an enviable balance sheet with enough current assets to pay all its liabilities.
  • KSB is undervalued in the region of 34% assuming no growth in FCF. Going on from here, anything below €400 is a very good entry point and will be a very good investment.
  • 80% of KSB’s ordinary shares are held by KSB foundation
  • KSB has a very good management and the pay is not out-of-line. The total compensation for the supervisory board is around €1 million and for the management board it is €4 million. There are 4 members in the board of management. As KSB does not declare the split between the managers, it is not possible to find out how much each one of them is paid, but this seems like a reasonable sum.


Additional disclosure: I do not own any shares at the moment because I wanted to analyze the company for myself. I plan to buy on Monday. I would like to thank Juan, the owner of the excellent Intelligent Investor blog and a GuruFocus contributor, for suggesting the company. Juan does own some shares of KSB.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 4.2/5 (26 votes)

Comments

batbeer2
Batbeer2 premium member - 2 years ago
Hi Chandan Dubey,

Good stuff, thanks !

I like KSB too. If memory serves IMI plc is a pretty close comp.

ROE is higher and so is the price. Any thoughts ?
cdubey
Cdubey premium member - 2 years ago
@Batbeer2: Thanks.

Yes, IMI plc is in the same industry and of similar size. I was not aware of the company. Yes, the RoE of IMI is higher and the stock is more expensive. But the company looks like a good idea, if the stock price drops a bit. I would look into it in more details.

Thank you for suggesting this.
Adib Motiwala
Adib Motiwala - 2 years ago
Chandan,

The enterprise value seems off ... How did you compute it ? What is the total debt and pension liabilities?
cdubey
Cdubey premium member - 2 years ago
I calculated ev as market cap+all liabilities-cash. I presume that pension liabilities are included in all liabilities. The data for calculating ev is in the first table for key figures.
cdubey
Cdubey premium member - 2 years ago
I understand that I do not need to count all liabilities, but I want to be safe on the correct side. :) But as you ask the pension obligation is 235.8 million and other employee benefits are at 143.7 million. LT debt is 109.6 million and the current liabilities are 405 million.
Adib Motiwala
Adib Motiwala - 2 years ago
I woud say EV is closer to 1 billion ( Adding debt + pension and subtracting cash). Valuation seems quite attractive and business has done well and shown good growth.
cdubey
Cdubey premium member - 2 years ago
Glad you like it. Am dipping in my coffers to buy some.
Jose Vasquez
Jose Vasquez - 2 years ago
Thanks for the kind words, ksb was my biggest investment in 2011, and I plan to hold it for long, Since the new ceo came some years ago (2005 if my memory serves well) it has done quite well. Now the margins are lower due to lower investments in big energy projects (due to the crisis) which has brought price competition to win the few projects available. Even then all the rest is doing well and energy investments will come back once the world economy recovers. Sales backlog is quite good and recent guidance says that this year will be at least as good as 2011, that sales will grow even faster than the backlog this year. So even if the economy does not get too bad we should do ok in the mid term. Actually the longer it takes the economy to recover the more chances we might have to keep adding at quite cheap prices.
Jose Vasquez
Jose Vasquez - 2 years ago
It is also worth noting that with the fear in Europe there have appeared quite some good prices and all stocks have been affected, but Germany is a powerful nation, with great engineering, and KSB is growing along with emerging countries. So it seems quite a safe investment. And the situation in Europe could be an opportunity to invest there if you chose the right companies. And their products are state of the art, with a big technological moat difficult to replicate, so it seems like quite a sustainable company for the long term.
cdubey
Cdubey premium member - 2 years ago
Thank you for adding your view point. Yes, I am looking at German companies at the moment. There were some good deals in October but the market seems to have recovered. Waiting for the next pullback.
marcolanaro
Marcolanaro - 2 years ago
Hi, interesting stuff.

Could you tell me why you think that KSB being owned 80% by a foundation is a positive? What is the objective or mission of the foundation?

thank you
cdubey
Cdubey premium member - 2 years ago


KSB Stiftung is a non-profit organization.
  • Otto Klein-Kühborth (heir to the founding member Jacob Klein as in K of KSB) transfers his majority stake in the company to the nonprofit foundation KSB Stiftung.
  • The voting rights attributed to KSB Stiftung were held by Klein Pumpen GmbH, Frankenthal.
From the annual report of KSB

"This ownership structure creates a stable footing for the successful long-term development of the company. Thanks to the work of Klein-Kühborth’s descendants not only at Klein Pumpen GmbH, but also in the Foundation and the Group as a whole, KSB has retained the character of a family-backed company to the present day."

The management sees it as a plus. Klein Pumpen is headed by two sons from the Kühborth family. I do not see a reason to disagree with the management. I will say that a family backed business is a plus. You will be getting good dividends and they will treat the business well.
marcolanaro
Marcolanaro - 2 years ago
Thank you.

In Europe there are so many companies that are "family businesses" and my concern is that they use them or see them as they personal turf and have little regard for minority shareholders, but seeing what the stock price is doing I believe the concern is overblown.

I am taking a good look at the company and I see it as a Buffett-type company, very quiet and not in fashion product but necessary ( it's not an iphone! or an ipad!), excellent cash-flow and the price is fair not excellent, but after all this is not a cigar-butt type of company.

I am taking a position and adding on weaknesses, I believe this company can be bought and I would not mind if the stock market closes for a few years.

Thank you again for your view of the company

Best regards,

Marco
marcolanaro
Marcolanaro - 2 years ago
I was looking at ROE. It amazes me that their calculations in the last annual report is between 17 to 26% for the last five years, while my calculations on the last semi-annual report give me a ROE of around 7-8%, any thought on that?

Best regards

Marco
cdubey
Cdubey premium member - 2 years ago
You have to take the earning before interest and taxes. In the balance sheet the earning before tax is 50m on equity of 820m. Add 9.5m of interest expense and then you get to a RoE of 7.25% for the HY-2011. Given this you would expect close to 15% RoE for 2011. The 2010 figure is 17.6% which is not very far away.

In fact the 2010 semi-annual figures give you 9.3m interest expense, 49m EBIT and 826m equity. This is RoE of 7.14% for the HY10. So, it seems like a seasonal aspect of their business.

marcolanaro
Marcolanaro - 2 years ago
I still do not understand why you use EBIT to calculate ROE, I use net income after interests and taxes. I used HY net income and doubled to get an aproximate yearly net income, and still got 7-8 %. I also wrote to the company but I have not received any answer.
cdubey
Cdubey premium member - 2 years ago
Yes, this is a bit weird. But if you look at the 5 year summary they have, they are definitely using earning before interest and taxes.

Update me if they reply. The correct calculation will be Net Income/Equity. Goes on to show why you need to verify the calculations.

marcolanaro
Marcolanaro - 2 years ago
Dear Cdubey,

I received a reply today. My question was not answered in detail but since the company pubblished the annual results today the investors relation department indicated to me that I could go directly to the annual report and look results. They failed to show me how was calculated. Though the IR told me that this year RoE is 14.2% compared to last year 17.6% due to lower earnings and higher equity. Sales are good. So I believe it is still a solid investment story
Steffen Jørgensen
Steffen Jørgensen - 1 month ago

Sorry double post. Please read below

Steffen Jørgensen
Steffen Jørgensen - 1 month ago

Hello.

I know this analysis is old but I would like to hear your opinion on a subject regarding KSB. I am also very interested in this company, but there is one single thing that frustrates me about the company:

They have enourmus liabilities to pension funds and other employee benefits as you can see on their balance sheet. They have around 520 mEUR in pension liabilities which is partly countered by their huge cash pile (I wonder why it is only cash and not some kind of marketable securities). If you look in note 8 you can see that they expect these pension expenses will grow from around 13 mEUR today to 20 mEUR in 3-5 years (page 104 if in their FY13 if I remember exact). I don't like to see so high pension liabilities but they are quite normal in Germany, but I am afraid that this will hurt the company's future profitability a lot.

What is your opinion about this?

Regards,
Steffen

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