After the 1H13 results, we have tweaked our model, which has resulted in a reduction in our EPS estimates for 2013-2015 of between 4-7%. We leave our target price unchanged at € 20, which is the average of the outcome from our DCF-model (€ 19) and historic multiples (€ 21). We maintain our Accumulate rating.
Some reflections on 1H13:
Our estimates were clearly too high, even vs. CSS. However, even though the gap in sales was larger at Industrial Services than at Flow Control, we were actually more surprised by Flow Control, where especially USA fell short of expectations with organic growth of circa 1.5%; other companies in this market reported healthier growth. In spite of sluggish sales in both activities, EBITA margins held up nicely, in spite of costs associated with greenfields, additional marketing efforts, (not quantified) restructuring at Industrial Services, and innovation-capex which requires 12-18 months before it bears fruit. So sales were lower than expected and margins were better than one would have expected given the sales trend. This is partly explained by a strategic decision to maintain prices amidst copper deflation, which was beneficial to profits (gross margin +60bp y/y to 60.3%) at the expense of volume. This was the second time since 1H06 that (group) gross margins exceeded 60%. (48,49 GBP, 0,35%) to the shortfall in EBITA, was a € 2m negative impact from IFRS-related items in the net financial result, and a slightly higher than expected tax-rate. As such, the shortfall in net profit was actually not as dramatic as the numbers initially suggested. The more so because management indicated that the trend in 2Q13 was clearly better than in 1Q13, which is promising for 2H13. In addition, Industrial Services should benefit in 2H13 from sequential improvement in the SPE market.
Re ROIC: Aalberts Industries has to gain volume while losing weight!
Management indicated they intend to focus more on ROIC, which has been sluggish over the past several years compared to pre-crisis levels of 16-17%, as mentioned by management (we assume this refers to pre-tax ROIC). Our calculations show that volume is the main factor that has pushed down ROIC: In 2012, Flow Control sales were an estimated € 90m lower in volume compared to the pre-crisis peak (adjusted for M&A and 2% inflation per annum). Assuming a gross margin of 50% in Flow Control and incremental opex of 50%, adding € 90m to Flow Control sales in 2012 would have yielded a pre-tax ROIC for the group of 15.5%, which is 170bp more than reported ROIC. We also believe inventories are too high. Group inventories/sales are on avg. 21.4% vs. an avg. of 15-16% for five other companies that operate in Flow Control’s end markets. However, Flow Control requires more inventories than Industrial Services so we assume it carries circa inventories of circa 24% of sales vs. 15-16% at the pure play peers. If management were able to lower this by say 500bp to 19% of Flow Control sales, in combination with € 90m higher sales volume, ROIC would end up between 16-16.5%, with the actual outcome depending on the operating leverage on working capital.