Stock Focus: Danieli S.p.A.

Michael, who already contributed on this blog (I strongly recommend his post on value investing available here), took a close look at the European Smaller Companies screen and has made some research on a stock he found appealing. Here it is.

Enjoy the read, don't hesitate to comment and share if you like it!

Regards,

Pierre

As a value investor, the European smaller companies screen provides me with a great hunting ground (check the screen here). One company that caught my attention is Danieli, the Italian steel specialist. Italy? Steel? No wonder the company is cheap. This must be a value trap, right? Well, let’s check it out. Danieli’s origins date back to 1914, when 2 Danieli brothers started a company in Brescia in Northern Italy to use Electric Arc Furnaces in steelmaking. In 1955 Luigi Danieli took over the family business (50 people) and started designing and manufacturing equipment for the steel industry, maximizing the use of automation. The first minimill was installed in Germany in 1964, and spread to Spain, the US and Asia. The company accelerated its growth under the leadership of Cecilia Danieli and her partner Gianpietro Benedetti (the current CEO). Following large investments in research, and M&A activity around the world, Danieli ranks today among the 3 largest suppliers of plants and equipment to the global metals industry (after Siemens VAE and SMS). The company is still 63% controlled by the Danieli-Benedetti family and has 2 businesses: Plantmaking (~70% of revenues). This is a high margin, high return business. It is driven by the need of more steel capacity in emerging markets. The plantmaking market is characterized by its oligpopolistic nature (the top 3 companies have a 60% market share), high barrier to entry and good pricing power thanks to its diversified client base (ie. steelmkaers such as Posco, Tata Steel). Danieli is a global player with facilities in China, India, Russia, Thailand, Vietnam, amongst others, and over 75% of sales in emerging markets. It has a flexible cost base with fixed costs representing around 10% of total costs. Steelmaking (~30% of revenues). Specialty steel manufacturing business (ABS - Acciaierie Bertoli Safau) making high quality steel for the Italian, German, Austrian construction and engineering sector. Danieli has made significant investment to restructure the business. Stelmaking was loss-making until 2004, and again in 2009-2010, but generated an EBITDA of €112m in 2012; it is currently undergoing a difficult phase. Danieli bought a plant in Croatia (not far from the Italian headquarters) in 2012 to reinforce this business. Below are the company’s key figures in EURm (the financial year ends in June): Measure 2005 2006 2007 2008 2009 2010 2011 2012 2013F Revenues 1495 2002 2457 3116 3210 2583 3112 3081 3000 EBITDA 156 179 231 290 317 287 359 313 325 Net Income 35 47 73 146 135 201 192 190 153 Book Value 508 554 598 709 830 1028 1186 1292 1440 Net Debt* (222) (460) (403) (702) (743) (869) (879) (825) (928) Order Backlog 1982 2149 3098 5071 3232 3682 3387 3225 3200 * Note from Strictly Financial: Negative Net Debt means positive cash position These figures show that: The business has been growing very strongly until 2008 (CAGR > 20%) and has stabilized since then. Note that the order book excludes a €600m contract in Ethiopia and the pipeline looks promising (e.g., Egypt, Abu Dhabi). Profitability has increased, with an EBITDA margin > 10% (despite headwinds from projects in Egypt and Libya resulting from the Arab spring). Return on equity remains high, above 10%. The company is very cash-rich, which is important given its cyclicality. Around €500m of cash come from client prepayments. So we’re talking about a profitable business with a long track record and strong balance sheet, well-positioned to capture the growth in global infrastructure. A closer look at valuation indicators confirms that the stock is cheap on all metrics. To illustrate the point, Danieli trades at only 3 times Enterprise Value (EV) on EBITDA (twice less than similar companies). Enterprise Value calculation: + DAN voting shares €840m (40.9m shares @ €20.47 per share) + DANR savings shares €540m (40.4m shares @ €13.36 per share) + Net financial debt (€500m) + Other net liabilities €200m = 1080m The company’s savings shares pay a slightly higher dividend than the voting shares (35 cents vs. 33 cents). They currently trade at a 35% discount compared to the voting shares, in line with the historical discount. Concluding thoughts: The fundamental value of Danieli is significantly higher than its current market price. The share price has come off recent lows (the voting shares traded at €15 during the height of the European debt crisis; I wish I had looked at the company at that time) but still offers good value. It seems that Mr. Market heavily penalizes the company because of its cyclicality, Italian roots, complex share structure. Some analysts view the potential award of large contracts as a catalyst. At current valuations and with a long-term investment horizon, I believe there is a sufficient margin of safety even without major contract wins. It is always comforting to invest along highly regarded investors (e.g., Bestinver, Alken, Pzena). Cheers, Michael Disclaimer 1: I have just bought shares of Danieli. "Put your money where you mouth is", right? Disclaimer 2: I am working for a Private Bank in Belgium. The views expressed here are mine and not those of my employer.