Description

Delfingen offers solutions for the protection of electrical networks and safe fluid transfer for the automotive industry and other industrial applications. Plastic protection products for the car industry are its largest business representing approx. 50% of the group’s revenue. In this niche-business Delfingen has held an 85% market share in the US since 2008 and recently doubled its market share in Europe to 60% with the acquisition of Schlemmer, one of its 2 main competitors. The company has also developed a number of other businesses such as textile protection products and fluid transfer solutions. Hybrid electric (HEV) and electric vehicles (EV) contain more and higher value-added protection products. The growth of HEV and EV should support both revenue growth and margin improvement over the medium term. Synergies from the Schlemmer acquisition and increased scale should also result in higher operating margins.

Delfingen has emerged stronger from the Corona-crisis thanks to tight operational management to avert liquidity issues and a transformative acquisition at a very attractive price. During the second half of the year, Delfingen acquired out of bankruptcy the European, Russian and North-African operations of Schlemmer, one of their main competitors. With the consolidation of the Schlemmer acquisition Delfingen added 50% to group revenue at a depressed valuation. Due to the covid crisis the company faced little competition in the acquisition process and was able to lower its price significantly. On top of that a strong recovery in the second half of the year resulted in better-than-expected revenue and results for Schlemmer. Management now believes a pay-back time of less than 2 years is achievable.

Although Delfingen’s share price has recovered strongly from the lows, we think the current valuation remains very attractive at 7.8x our estimate of this year’s after-tax earnings for a company with a strong competitive position and the ability to grow earnings over the medium term.

BUSINESS

Delfingen was founded by Emile Streit in France in 1954 and the family still owns a ca. 64% stake today.  Gerald Streit, the founder’s grandson, joined the group in 2011 and became CEO in 2015. The company’s main businesses are plastic and textile protection products and fluid transfer solutions for the automotive industry, mainly in Europe and the US.

Plastic protection products (50% of revenue)

Delfingen manufactures plastic protection products and is a tier 2 supplier to the car manufacturers. At first glance the products look very similar from manufacturer to manufacturer and model to model but there are differences resulting in 1000’s of SKU’s. Products differ in length, thickness and design. The production of cable protection products is a well-established technology. Generally, clients have several suppliers, including small local players with weak financials, but the market is consolidating. Historically, cable protection was a commodity with low switching costs and therefore intense price competition. This is less and less the case today with increasing quality requirements from the OEM’s. Delfingen has an 85% market share in the US and with the Schlemmer acquisition, a 60% share in Europe. Their market share in Asia is much smaller. Niche players in an industrial activity require scale to be efficient. Both clients and suppliers are large companies such as Bayer and VW. A large market share in a niche is essential to maintain pricing power and to impose your technology. For a small company such as Delfingen, building an international presence to supply clients all over the world is expensive and a large market share is essential to generate an attractive return. Scale and quality of its products and services makes Delfingen the partner of choice for its clients. Delfingen  has a ca. 85% market share in the US since 2008 after completing 5 acquisitions. There was a risk that clients would not accept such a dominant market share. This has not been the case and the US has been  their most profitable market. Scale allows Delfingen  to earn decent margins at prices that are attractive for clients. New entrants would have to accept losing money for a period of time as they would have to offer lower prices while lacking scale. With Delfingen’s focus on quality and service a challenger would also have to attack Delfingen’s preferred supplier status. In the automobile industry, suppliers are rated monthly with scorecards and Delfingen claims to be the top provider. Schlemmer has tried to gain market share in the US for years while losing $20m per year and was not successful. Prior to the Schlemmer acquisition there were 3 large players in the plastic protection market in Europe: Delfingen, Schlemmer and FRW Fränkische. Delfingen now doubled its market share to approx. 60%. Fränkische is active in several industries and generates sales of €400mio. Automotive is not their largest business. 

Textile protection products (17% of sales)

Textile protection products have been added more recently to Delfingen’s products range. This business represents already 25% of the cable protection business and is growing fast. The main driver is the growth of HEV and EV where textile is one of the preferred protection solutions because it takes up less space than plastic and is better suited for the thermal and electromagnetic environment. Delfingen is a challenger in textile protection products and is gaining market share in a consolidating market. Federal Mogul (Tenneco Group) is the market leader but the rest of the market is still fragmented. Delfingen is the only player focused on the car industry offering both plastic and textile cable protection. Its main competitors are specialized in either plastic or textile and focus on multiple industries. The advantage for the clients is that they only have to manage one supplier with the capability of delivering its products all over the world.  

Fluid transfer solutions (15% of sales)

Delfingen is a very small player in fluid transfer solutions with sales of €60mio in a multi-billion market. The company focuses on niche applications such as fuel tanks, battery cooling systems and sensor cleaners for self-driving vehicles.

GROWTH

Technological developments are the main growth driver for Delfingen’s markets with self-driving cars, HEV  and EV. Content per car for wiring protection is $33 for ICE (Internal Combustion Engines), $44 for EV and $61 for HEV. The increase in content is due to higher volumes and increased complexity. For example, HEV and EV require a higher level of protection for temperature and electromagnetic radiation. If a power cable is cut and touches the bodywork, this is a high safety risk. These types of risks require new solutions and explain why this industry has become less of a commodity. Gradually this industry is becoming more R&D intensive with protection solutions for specific risks using textile, composite materials etc. HEV and EV have a small market share today with significant growth potential for many years to come. Delfingen is confident that it will be able to continue to outperform the automotive market as they have been doing for several years already. Management referred to research by Roland Berger, a specialist in market research for automotive, with a growth forecast of 3,5% p.a. for plastics and 5% for textile. In addition to market growth, Delfingen is gaining market share in textile protection from smaller players unable to offer a global service and also from Federal Mogul. Market share gains in plastics are unlikely considering their dominant position. Recently, the sales of HEV  and EV is accelerating as a result of government incentives. The long-term growth potential for EV received another boost a few weeks ago by the investment plans announced by VW and BMW. The VW brand expects 70% of sales in Europe and more than 50% of sales in the US to be electric by the end of the decade.

With mid-single digit sales growth and taking into account the investment required in Schlemmer’s IT systems and production, management estimates normalized capex at 5% of sales with working capital at 15%. 

SCHLEMMER ACQUISITION

Schlemmer was a direct competitor to Delfingen with a comparable market share in Europe of approx. 30%. Schlemmer had a strong market position in Germany with cable companies such as Leoni, Dräxlmaier and Kromberg & Schubert. Many of its clients stayed loyal to the company despite its financial problems and issues with the supply chain and quality. In the US, Schlemmer pursued an aggressive price policy to gain market share but they were unsuccessful despite losing $20m per year. An aggressive growth strategy and too much debt pushed Schlemmer into liquidation in December 2019. Delfingen purchased the activities in Europe but the Asian business was sold to Schlemmer’s Chinese JV partner. In terms of the organization, a lot of work has been done in collaboration with the liquidator prior to the acquisition such as for the loss-making sites in the US, Mexico and Brazil that were put into liquidation and production discontinued. This should allow Delfingen to acquire $10-15m revenue for “free” as nobody else will acquire these sites. Delfingen also retained just 50 employees from the Schlemmer HQ out of a total of approx. 250. Schlemmer’s IT was obsolete with many different systems. The integration into Delfingen’s IT systems will require a significant (financial) effort. Production will also require some investment. 

The combination of a low acquisition price due to the COVID-19 crisis, and a performance that has far exceeded management expectations as a result of a strong market recovery, especially for HEV and EV, is now likely to result in a pay-back time of less than 2 years. The acquisition was funded by a combination of debt and equity and net-debt has increased to close to 2x EBITDA. Current profitability levels will allow the company to quickly reduce debt to below 2x.

VALUATION

When the Schlemmer acquisition closed in September of last year management guidance for 2021 was revenue of €320m at a 5% operating margin. This compared to revenue of €231m in 2019 and was based on an expected contribution by Schlemmer of €100m. Revenue was expected to grow to €400m by 2024 with operating profit of €36m (9% margin). Target operating margins are higher than the historical margins of 6-7% due to changes in the business mix, the improved market position, scale benefits and synergies from the Schlemmer acquisition. The growth of HEV and EV support growth of both revenue and margins as the business mix changes to more products with higher added-value. Increased scale and synergies in R&D are also supportive of higher margins. Results since the acquisition have far exceeded management expectations. Additionally, in December Delfingen acquired the stakes in certain Schlemmer JV’s that were not part of the initial acquisition such as 51% of Schlemmer Italy, 38% of Schlemmer Morocco and 50% of Schlemmer Tunisia. These businesses were generating €25m in revenue at 20% EBITDA margins.

A few days ago the company gave guidance for this year with  €370m of revenue and operating margins of 8% to 9%. At the current share price the business is valued at 7.8x our estimate of this year’s after-tax earnings. 

CONCLUSION

Delfingen has a market-cap of €136m with 29,2% free-float and is a below the radar opportunity for most. The company benefits from the long-term growth potential of HEV and EV, a trend that received another boost by the increased incentives as part of the economic recovery packages in response to COVID-19. The Schlemmer acquisition increases revenues with more than 50% and doubled the size of its European business. The double impact of a low acquisition price and a strong market recovery ensures significant value creation. Synergies, stronger market positions, increased scale, operating leverage and a change in business mix towards more value-added products are all supportive of higher profit margins. At a P/E of 7.8x we believe the risk-reward is attractive for a business with the above characteristics.

RISKS

- Chinese competitor entering the market in the US and Europe

- A downturn in the car industry which would not be compensated by the growth in HEV and EV

Catalyst

2021 results reflecting the earnings power of the current business