First off, a quick note: Felix is working for an investment bank for a couple of weeks, so he will not be involved in the reporting on German stocks for that period.
Today I would like to present you, in this quick write up, the SMT Scharf AG – ISIN: DE0005751986. SMT Scharf was founded in the year of 1951 and is based in Hamm which lies in the old industrial and mining arear of Germany the so called “Ruhrpott”. SMT Scharf is listed on the German stock exchange since the year of 2008 and the first time I heard of it on a value investing conference was in the year 2012. The company and the investment case was presented by the guys of the Frankfurter Aktienfonds für Stiftungen. Since than the development of the share price looks like this:
SMT Scharf is the world market leader for the production, installation and maintenance of underground rail-bound railway systems which are used in the hard coal mining business. Its market share in this segment is over 40%, you can find an interview with the CEO from the year 2013 here, the number of installed rialways is really interesting due to the fact that you can calculated the future service revenue with it.
Das Segment, das Scharf bedient, sind „Einschienenhängebahnen“ = „Monorails“, eine sehr spezialisierte und kleine Nische: Weltweit gibt es etwa 1200 bis 1400 Monorails, wovon etwa 530 von uns sind, daraus resultiert unser 40%-Marktanteil. Der Jahresumsatz in dem Segment sind etwa 250 neue Bahnen (100 Mio. EUR) und eben so viel Service, also ca. 200 Mio. EUR. Auch davon hat Scharf mit 77 Mio. fast 40%. [https://translate.google.com/]
Despite the fact that SMT Scharf is based and listed in Germany, due to the fact that over 91% of its revenue come from abroad, it is more or less an emerging markets play. The key countries are China, which stands for 29% of revenues, followed by Russia and other states of the GUS (21%), Poland (18%) and South Africa (15%). A further interesting fact is that SMT Scharf is the German company which makes the highest proportion of its revenue in Russia.
Due to the rising demand in commodities the last years were really good for SMT Scharf. In the following chart you can observe the change in EBIT-Margins and the strong development in equity.
Already in 2012 the guys from Shareholder Value where really excited about the high level of stable recurrent earning of the company which come from the high maintenance and service spending’s on already installed rails. When I remember correctly, one perosn told me that over a 5 year cycle a costumer has to spend 2/3 of expenditures into maintenance and services and 1/3 are the initial installation costs. At the moment service stands for 49% of the overall revenues of SMT Scharf. Due to the lock-in effect the sustainable EBIT margin on the service segment shut be around 20%.
What is really interesting, is that the normally so stable service segment has taken a strong hit as well, the revenue in this segment is down to 30,8 Million Euro from 44,3 million in the year of 2012. In my opinion, the only reasonable explanation for this contraction is that the service is linked to hours of usage, (in the heavy machinery business you also write down your tools in accordance of usage hours). I think that you will see a further decline in earnings in the new half-year report which will be published at the 14.08.2014.
Now we come to the interesting fact, due to the relatively low share price and net cash on balance sheet SMT Scharf is valued with an Enterprise Value of a little bit less than 70 Million Euro at the moment. As a long term investor I’m normally willing to pay a 10x EBIT multiple for recurrent earnings. When SMT earns its 20% EBIT Margin on its service business they will earn an EBIT of 6,16 Million Euro on the depressed level of 30,8 Million in service revenue.
To put it in a nutshell, at the moment you can buy this business for 10x EBIT on its depressed service earnings and get the rest of the business nearly for free. When they come back to a normal level in maintenance revenues it would be a buy for an EV/EBIT of around 8 + the rest of the business for free.
Some red flags have to be mentioned:
- The high level of sales in emerging markets
- The potential bribery problematic in China, Russia and the inherent potential tail risk.
- Until not long ago you had a mediocre management and board, this was changed on the last general meeting by Shareholder Value Management AG.
- Related to 1., they have a subsidy in Donetsk Ukraine and an overall high level of sales in Russia which can lead to a further drop in profits and revenues.
I have not invested in the company in 2012 and will not do it in the future due to the fact that we follow a sustainable approach. Furthermore SMT Scharf is mainly active in China and Russia where it is kind of normal to bribe people to do business. Therefore there is a potential tail risk due to the fact that china has increased its anti-bribery efforts. I’m not stating that SMT Scharf is really involved in bribery but I cannot exclude this risk for myself.
Have a great week! NH