Professional Documents
Culture Documents
13 August 2013
This issue includes brief thoughts on the tone (and at least one transformation) of business
in the electrical equipment marketplace during the Q2 earnings season (John Quealy and
Chip Moore), a related, bullish (and timely) call out of our European capital goods practice
(Andy Bell), while we wrap up with a more cautious view on a specific part of the
lighting/LED ecosystem from our resident experts (Jed Dorsheimer and Josh Baribeau).
Earnings season – not sensational, but supportive of the recent market strength in
Industrials…
At a high level, we found second quarter earnings across the Industrial sector to be in line
and even encouraging in many areas (e.g., energy) while pockets of weakness seem smaller
yet continue to dampen specific sub-sectors (e.g., utility spending). By geography, North
American markets for the most part supported growth, along with Asia, while Europe,
Latin America and the Middle East appeared to offer more variable observations. As a
sector, Industrials held up well in terms of meeting and beating estimates (see below).
Canaccord Genuity is the global capital markets group of Canaccord Financial Inc. (CF : TSX | CF. : LSE)
The recommendations and opinions expressed in this research report accurately reflect the Investment Analyst’s personal, independent
and objective views about any and all the Designated Investments and Relevant Issuers discussed herein. For important information,
please see the Important Disclosures section in the appendix of this document or visit Canaccord Genuity’s Online
Disclosure Database.
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13 August 2013
Figure 1: ~74% of S&P 500 Industrials have surpassed EPS expectations (~90% reported)
For example, month on month order trends for the electrical equipment and capital goods
leader Emerson Electric began to grow again after a tough H1/13 (see Figure 2 below),
perhaps most encouragingly in Network Power, which saw an increased level of activity in
the European datacenter market for the first time in several years (a data-point that fellow
supplier Eaton Corp. also reported and that appears encouraging for enterprise/industrial
Ethernet vendor Belden – see our note below). At the same time, Industrial Automation
trends also seemed to improve a bit for Emerson, a proof point supportive of the recent
Schneider purchase of Invensys. Here, we agree with our colleague Andy Bell, who has
previously highlighted revenue synergy potential given Invensys' customer base of leading
global petroleum, chemical and food & beverage companies – areas where Schneider is not
so strong given its focus on non-residential and utilities & infrastructure customers (while
Schneider is a leading global discrete automation company, it currently has no presence in
process automation where Invensys is one of the top six players globally).
hardware and software) last Thursday after over 25 years of serving the U.S. marketplace.
(Interestingly enough, ESCO itself is an Emerson spin-off from 1990 – a transaction
expertly chronicled in the acclaimed value investing testament “Margin of Safety” by Seth
Klarman).
Figure 3: Margin of Safety: Risk Averse Value Investing Strategies for the Thoughtful Investor
RECENT RESEARCH
Investment highlights
End-markets stay variable near-term, while order trends improve modestly (GFI
outlook stays subdued). The monetization of embedded is a clear positive, shifting
focus to core operations (and driving incremental buyback of ~$600M). FCF stays very
strong (~$1.77B YTD), supporting additional M&A opportunities.
Management expects underlying sales growth in F2013 of ~1% (from ~1.5-2.5%), with
EBIT and pretax margins roughly flat y/y (ex goodwill charges). Full-year EPS
guidance is anticipated at the lower-end of the ~$3.48-3.58 range (implying Q4 closer
to ~$1.11).
Our estimates (now ex-embedded for '14) adjust to: F2013 to $24.7B/$2.78 (from
$24.9B/$3.48); F2014 to $24.7B/$3.80 from $26.0B/$3.85.
Europe flat
Asia flat
Network Power: $1.51B/8.1% vs. our $1.53B/8%. Sales decreased ~5% (reported and
underlying), as continued telecom weakness offset increased demand for data center
infrastructure (embedded computing and power business down double-digits on
product rationalization and difficult end markets).
As mentioned, Emerson announced the pending sale of the embedded business, with
Platinum Equity agreeing to purchase a 51% stake for ~$300M cash (expected close in
~3-6 months). Results will continue to be reported in Emerson's 2013 results, while
the equity method of accounting will be used (49% interest) once the transaction is
complete (with goal of exiting remaining 49% stake in ~3-4 years). Notably, this
business served as roughly a 200bps drag on sales growth and 150bps drag on
margins in '13.
U.S. down ~3% (residential AC paused after very strong Q2, impacted by mild
weather and destocking)
Looking forward, management expects growth to resume for residential AC, with
improving commercial market demand.
Commercial & Residential: $472M/20.4% vs. our $500M/22%. Sales decreased ~2%
(underlying sales growth of ~4% after adjusting for Knaack divestiture). Growth was
driven by continued growth in NA residential investment (offsetting weaker
commercial demand).
Management expects modest growth to continue near-term, with solid residential and
improving nonresidential demand (Europe stabilizing).
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13 August 2013
Guidance: Management now expects underlying sales growth in F2013 (September) in the
range of ~1% (from ~1.5-2.5%), with EBIT and pretax margins still roughly flat y/y (ex
goodwill charges). Full-year EPS guidance is now expected at the lower-end of the prior
~$3.48-3.58 range (excluding charges, with GAAP closer to ~$2.78). FY14 growth is seen
in the ~2-4% range currently based on global GFI trends.
Balance sheet: Emerson had total cash and equivalents of ~$2.81B as of 6/30/13 (from
~$2.62B at 3/31/13), with total debt unchanged at ~$5.545B. The company generated FCF
of ~$850M in the quarter (vs. ~$705M in Q3/12), bringing year-to-date FCF to ~$1.77B (vs.
~$1.31B in equivalent period last year). Full-year FCF is projected at ~$2.7B. The sale of
embedded (and related tax repatriation) drives incremental buyback of ~$600M. M&A
appetite looks to bump up to ~$1B in '14 (from ~$100M in '13)
Valuation
Our 12-month target of $65 (from $60) equates to ~9.8x our F2014 adjusted EBITDA
estimate of $5.1B.
Risks
Global macro conditions, M&A integration, commodity costs, FX fluctuations and
competition are among the risks.
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13 August 2013
Investment highlights
A solid quarter, as emerging markets growth (~13.5%), share gain and mix helped
offset a variable demand across developed markets (driving record profitability).
Notably, European enterprise spending looks to be improving, which could be a
welcome tailwind in 2014+.
The balance sheet stays robust (FCF ~$46.8M), supporting M&A (“dry powder”
~$468M) and buyback (~$162.5M remaining).
Industrial Connectivity ($171.9M/14.4% OM): Sales decreased ~1% y/y (flat organic after
adjusting for copper, currency and inventory adjustments). Organic growth outperformed
market trends, driven by strength in emerging markets (offsetting European challenges)
and continued success with the global accounts program. Adjusted operating margins of
14.4% reached longer-term corporate goals (driven by higher volumes and productivity).
Industrial IT ($58.1M/$19.5% OM): Sales increased ~3.4% y/y (+2.2% organic adjusted,
+8% year-to-date), while adjusted operating margins of 19.5% increased ~70bps y/y and
190bps q/q (with good leverage on growth).
Enterprise Connectivity ($132.9M/11.1% OM): Sales increased ~2.7% y/y (3.5% organic
adjusted), while operating margins improved ~340bps sequentially. Management remains
focused on opportunities for margin expansion (further expansion expected), with product
mix and growth in emerging markets expected to be favorable looking forward.
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13 August 2013
Broadcast ($169.7M/14.2% OM): Sales were up significantly y/y as expected, with Miranda
and PPC contributing a combined ~$103.5M (both performing in-line with expectations).
Core demand was soft (expected), as Q2/12 benefitted from the cyclical impact of
Olympics/elections (~$2-4M y/y headwind) and PPC organic growth was negatively
impacted by deliberate product rationalizations (~$2-3M). Secular tailwinds remain firmly
intact looking forward, with operating margins increasing ~90bps sequentially.
Balance sheet: Belden exited the quarter with total cash and equivalents of ~$476.2M
(from ~$469.4M at 3/31/13), with total debt of ~$1.33B (unchanged). Cash generated in
operations was ~$58.6M for the quarter excluding 1x tax items (~55.3M YTD, with FCF of
~$38.2M), with expectations for continued strong NI conversion in '13 (100%).
The balance sheet stays strong overall (at goal of ~2.5x net debt/EBITDA, with
management estimating total “dry powder” of ~$468M at quarter end (as M&A remains a
distinct priority). Belden also repurchased ~584K shares for $31.25M in the quarter (4.9M
shares repurchased to date, with ~$162.5M of availability).
Outlook: Belden increased the midpoint of F2013 expectations, now targeting adjusted EPS
of ~$3.54-3.69 (from $3.49-3.69), with sales in the range of ~$2.09-2.12B (from ~$2.07-
2.12B). Q3 sales are expected in the range of ~$525-535M (yielding adjusted EPS of
~$0.90-0.95). Guidance factors quarterly interest expense of ~$19M and a ~25% tax rate.
Valuation
Our 12-month target of $70 (from $62) equates to P/E and EV/EBITDA multiples of ~17x/~11x
our ‘14 estimates, respectively.
Risks
Global macroeconomic conditions, lumpy and seasonal sales patterns, commodity costs,
competition and M&A integration.
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13 August 2013
Investment highlights
We favor bold moves like this - divesting Aclara (~$225M/$0.25 run-rate) in hopes of
buying a complimentary “niche” technology business that follows the more consistent
return profile like the remaining assets of Filtration and Test.
The company hopes to close this sale in 60-90 days (our sales price estimate is roughly
~1x EV/Sales) and then pay-down debt while a suitable strategic purchase is identified.
While the quarter results get de-emphasized given this news, guidance gets formally
reset, with adjusted EPS (ex Aclara) forecast in the range of ~$1.35-1.45. Underlying
bookings remain firm.
We adjust our estimates for the Aclara sale and related debt repayment. Specifically,
our FY13 rev/EPS estimates go to $558.4M/$1.45 from $705.4M/ $1.60, while FY14
goes to $552M/$2.25 from $772M/$2.50.
Q3/13 review
The Aclara business is comprised of the AMR (powerline carrier and RF) and utility
software businesses, primarily to domestic utilities. As we have noted in the past, the
lumpiness, regulatory scrutiny and competitive pressures inherent in that business are
formidable, and we can certainly understand the motivations behind the management's
decision. Importantly, the Company has elected to keep the more steady and predictable
Doble business as the core of its reformulated Utility Solutions Group.
Last night, ESCO reported Q3/13 revenue/GAAP EPS from continuing operations of
$116.9M/$0.24. More importantly, management announced plans to sell the Aclara
business (expected in next ~3 months), thus classifying related sales as discontinued
operations. While not comparable, we modeled $182M/$0.40 vs. the Street at
$188.6M/$0.55, both including Aclara. Adjusted for non-recurring restructuring charges,
reported EPS (continuing ops) would have been ~$0.33.
On a continuing basis, total sales of $117M were roughly flat y/y, with increases for
Filtration ($53.8M, +5.5%) and Doble ($26.6M, +3.6%) offsetting a ~$5M decline for Test
(down ~12.6% to $36.6M on timing of large contract deliveries). Gross margin improved
~120bps y/y, reflecting recent restructuring of the Test segment.
New order bookings (continuing ops) were ~$141M, resulting in a 1.21x book-to-bill. The
composition of the new order bookings was as follows: Filtration $62.3M (1.15x), Utility
Solutions (Doble) $26.7M (1.0x), and Test $52.2M (1.43x). Backlog was up 17% y/y to
~$288.5M.
Valuation
Our $34 price target is derived by applying a 15x multiple on our F2014 EPS estimate of
$2.25.
Risks
The diversified business model has elevated cyclicality and complexity.
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13 August 2013
Valuation
Legrand trades on 2.5x 2013 EV/sales compared to an adjusted EBITA margin of 19.9%.
The EV/EBITA multiple is 12.8x and the PE is 18.5x compared with the sector on 13x and
17.9x respectively. Our DCF fair value is €44. To support our PT using Quest™ we have to
delay the fade by 5 years and increase real growth to 7% which, given the management
track record, we feel comfortable with.
*Please note that analyst data and Quest data may differ due to different sources and calculation
methods. The Quest analysis on this page is based on consensus forecasts
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13 August 2013
66% of sales (57% in 2007) with either number 1 or 2 products in any given market
Emerging markets account for 63% of production headcount, 51% of sales and marketing
headcount and 25% of R&D headcount in 2010.
Digital infrastructure
Energy performance
Home systems
R&D spending accounts for around 4.5%-5.0% of sales (2,100 R&D staff) and the company
indicates that 53% of capex is linked to new products, which represented 37% of 2012
sales. Future product development opportunities include:
Cost cutting
Cost cutting measures have been taken over the past years by moving more production to
low cost countries, outsourcing non-core components and simplifying the product range,
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13 August 2013
reducing the number of components by 60-70% on the group's range of 200,000 products.
The number of platforms has been cut from 30 with 85 ranges to 11 platforms and 60
ranges (2014 target: from 5 to 2 in Europe, 1 in US, 10 to 3 in China, 8 to 1 in Latin
America, 2 to 1 in India, 1 in Australia, 3 to 2 in International division).
This has helped the group raise its adjusted operating margin from 14% (1990-2002) to
16% (2003-2009) and to the new target level of 19-20%.
The company has announced 5 acquisitions since the beginning of 2012 with sales totalling
€180m. These deals should boost 2013 revenue growth by 2%. 72% of sales of the acquired
businesses are in emerging markets and 72% of acquired sales are in the area of new
business segments.
Since 2004, the group has acquired 32 businesses with combined sales of €1.1bn. The aim
is to buy companies at or below the group's own multiple and raise margins to the group
level over a period of around 3 years. Acquisitions are dilutive to the group margin in the
short term (~30-50bps) as target companies typically have margins between 5% and 15%.
In 2012, the margin hit was 30 bps on an underlying level of 19.9%.
Over the past 25 years, the company has only made two larger acquisitions (BTicino* and
Wiremold). While further larger deals are not excluded, these will remain infrequent.
* Arguably one of the most successful deals in capital goods over the past 25 years
SWOT ANALYSIS
Strengths
Management track record over past 20 years - organic growth coupled with a bolt-on
acquisition policy. Strict cost control.
Pricing power (pricing positive over past 20 years) – driven by market share, product
innovation and strong position with buyers (mainly electricians)
Strong cash generation (at 11.1% per annum, second highest free cash flow margins in
the sector over the past 10 years)
Balanced currency exposure (50% of sales and costs in €, 15% of sales and costs in
US$)
Weaknesses
High exposure to low-growth markets France and Italy (representing 33% of group
sales combined)
Opportunities
Growth opportunities in emerging markets, which remain fragmented
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13 August 2013
Recovery in North American market (17% of sales), where the group continues to gain
share
Take-over candidate
Management
The management team, led by Gilles Schnepp (Chairman and CEO, joined company in
1989 as deputy CFO), has been in place for many years, including the LBO period
(following a failed take-over attempt by Schneider, the group was purchased by KKR and
Wendel and was taken private between 2002 and 2005). Legrand has a very strong
corporate culture and has been able to drive organic growth while continually raising
prices through product innovation and a strong position with distributors. At the same
time, the group has been successful in buying and integrating new companies, often
purchased at multiples below the company's level. Where acquired companies have had
lower margins, these have been raised to the group average in most cases after several
years. Given the focus of the business, management knows the end markets extremely
well, enabling the company to find the right companies to fill product or geographical gaps,
often at the right price. Through a make-or-buy policy and increased production in
emerging markets, Legrand has substantially reduced capital intensity in the business,
reflected in a fall in capital expenditure as percentage of sales from over 8% in 2000 to sub
3%. Mr Schnepp owns 0.73% of the shares.
Performance based culture: The heads of countries are driven to be entrepreneurial with a
performance-based remuneration model. At the beginning of the year, multi-scenario
budgets on sales, costs, capital employed are set up. These are monitored on a monthly
basis and during a quarterly interactive meeting between group management and country
management, potential adaptations are implemented if needed to due changes in the
macro environment.
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13 August 2013
Investment highlights
We believe that Acuity remains one of the best companies in the lighting space, but we
find that much of the upside to estimates is already priced into shares after an
impressive run over the past 18 months.
The company has done a very good job of outgrowing the lighting market, gaining
share in a flattish recovery while maintaining its GMs amid mix/price competition. It
has also shown a willingness to make the difficult decisions to cut legacy costs,
offsetting much of the required investments in new markets and technologies as well.
Economic data signals a continued recovery in the US construction market. Acuity
combines this macro tailwind with the secular trend of solid state lighting, which we
see hitting an inflection point in 2014.
Our model is already factoring in a reasonable amount of TAM expansion, share gains
and the operational performance (leverage) described above, limiting further upside to
numbers. With limited upside we do not see much more room for fundamental
multiple expansion; however, we do recognize that momentum for SSL names could
take shares higher in the near term.
As AYI should be a core holding throughout this trend, we would look to become more
constructive on pullbacks or signs our estimates are proving conservative.
Valuation
Our price target of $78 is unchanged based on our CY 2014 EPS estimate minus net debt
per share. We have adjusted our model slightly. We have factored in higher revenue
growth based on better-than-expected LED momentum, gains in the retrofit/re-lamp
market and a recovery in non-residential construction. We were probably a bit too
aggressive in our OPEX assumptions previously, especially following the additional fixed
cost of the company's two recent acquisitions without commensurate revenue offsets.
However, even after increasing the company's SD&A, we still show a good degree of
operating leverage as volumes ramp, albeit at a lower rate. The net effects of the higher
revenue growth with higher OPEX approximately cancel each other out.
Investment risks
Acuity is exposed to the following risks: 1) spikes in the costs of raw materials such as
metals and petroleum, much of which is not hedged or cannot able to be passed on in the
form of price increases; 2) a high correlation with the seasonality and cyclicality of national
construction spending and general business trends; 3) competition from both the
numerous large and small lighting companies in the industry; 4) a pause in technological
development of further product differentiation; 5) changes in environmental, health and
safety regulation.
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13 August 2013
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Price Chart:*
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13 August 2013
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13 August 2013
Canaccord Genuity BUY: The stock is expected to generate risk-adjusted returns of over 10% during the next 12 months.
Ratings System: HOLD: The stock is expected to generate risk-adjusted returns of 0-10% during the next 12 months.
SELL: The stock is expected to generate negative risk-adjusted returns during the next 12 months.
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13 August 2013
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Daily Letter | 22
13 August 2013
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