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Ferronordic: Swedish power to Russian construction

Oscar Lara Rapp (@oscar_l_r)


Business

Today we are going to talk about Ferronordic (CPH: FNM). The company, founded in 2010, is the official dealer in Russia for Volvo CE (the third largest manufacturer of construction equipment in the world), Terex Trucks, Dressta, Rottne and Mecalac. The main business of Ferronordic is the sale and aftermarket of big machines such as excavators, wheel loaders, articulated hauls or road construction equipment. As you know, these machines are employed in different construction industries, what entails an important customer diversification.

 

 

% of 2017 revenues

Sale of equipment

69 %

Aftermarket of Volvo

and Renault Trucks

27 %

Others (consultancy, other contracts)

4 %

 

Customers

% of 2017 sales

Mining sector

33%

Road Construction

21 %

General construction

20 %

Quarries and aggregates

11 %

Forestry

14 %

 


However, this business is not only about selling machines but about providing exceptional after-sales services. Indeed, customers know very well how a poor after-sales service detract greatly from the value provided by the dealer, being this a decisive factor in their purchase decision. Let's think about your own car for a second. What happens when it breaks down? I guess that's not a very pleasant situation for you. You have to take it to the mechanic, wait for a week (at least) until it is repaired and, in the meantime, you have to try to convince your wife to let you use her car. Well, when it comes to this kind of machines the situation is even worse. If a big wheel loader breaks down, taking it to a workshop is rarely economically feasible and, in certain cases, it could even become impossible for practical reasons. That's why dealers have to send their mechanics to the place where the machine is. Even more, they have to do it as fast as possible, since machines standing idle quickly result in major costs and deteriorating profitability for the customer. This explains why, in developed countries, purchasers of construction equipment tend to focus more on the total cost of ownership over the machine’s life-cycle rather than just on the initial price. This is usually a serious handicap for Chinese manufacturers, which sell cheap machines but are not able to provide a reliable after-sale service. However, in Russia this is different. In this country purchase price has been prioritized over life-cycle costs until recently, but this trend has just started reversing. And, of course, since Ferronordic sells a high-end product (Volvo CE enjoys a strong brand image in Russia) with a premium after-sale service, this is good news for them!

 

From the point of view of the company, this after-sale service establishes a very interesting dependence between the customer and the dealer. Once a customer buys an expensive piece of equipment, the official and certified dealer is likely to start a long relation with him, resulting in regular and significant future cash flows. This is a valuable and strong dependence for Ferronordic, specially taking into account that Ferronordic is the only Volvo CE official dealer in Russia. However, this dependence can be partially weakened by the competition coming from unofficial dealers. In order to mitigate this risk and to strengthen this dependence as much as possible, Ferronordic is implementing solutions such as the development of a system for digital sales support, whereby signals from the machines’ telematics system (e.g. Volvo CE’s CareTrack) are automatically transformed into proposed sales actions for both equipment sales and aftermarket sales.

 

Said that, this business is not only about micro-economic elements. The construction sector is very intertwined with the Russian economic cycle and hence, with all aspects affecting this cycle, such as oil prices or external sanctions. If we take a look at Russian imports of construction equipment as published in the 2017 Annual Report of Ferronordic, we can clearly see how they evolve according to Russian macro-economic events.

 

 

In 2014 we saw how the Russian economy was seriously hit by the oil crisis. Its recovery is still underway, helped by higher commodity prices. Yet, there are still important concerns such as new US or European sanctions. This the negative part. However there is a more positive one. If we investigate a little bit about Russian infrastructure , we will clearly see how Russia requires very significant infrastructure investments (awful roads!). Indeed, Russian government is aware of it and they are already announcing plans for increasing investment in infrastructure, what means a possible higher demand for construction equipment in the future, especially when there is a pent-up demand on the Russian market for at least 60,000 units of construction equipment. And here we have again Ferronordic as a player who can benefit from it.

Competitors

As previously explained, this sector can be clearly divided into two groups. Firstly, we have manufacturers/distributors offering higher quality construction equipment and good aftermarket support but at higher prices, such as Caterpillar, Komatsu and Hitachi. This is the sector where Ferronordic works.

 

Then, we can find Chinese brands that offer cheaper equipment with inferior aftermarket support. They have historically accounted for 32% of the units of construction equipment imported to Russia (in value they represent a much smaller part of the imports). Ferronordic does not consider the Chinese construction equipment manufacturers to be as important competitors as the previous brands.

Management

In 2016-2017, Hakan Eriksson bought 15.5 % of the shares and took new people to the board. Even though we have seen this board working for a short period of time, so far they have made sensible decisions:

  • Redemption of most preference shares issued in 2013 through conversion to ordinary shares and cash redemption.
  • On 29th September 2017, the Board announced that Ferronordic intended to list the ordinary shares in the company on Nasdaq Stockholm and diversify the ownership of the company, partly through an issue of new ordinary shares, and partly through a sale of existing ordinary shares.

Financial results and situation

As we have said, Ferronordic depends a lot on Russian macro-economy and its cycles. We can clearly see it in their 2015 results, when sales plunged. In 2017 Russian economy has improved and so has sales, reaching a historical high. That's good, but what's really remarkable is the evolution of the operating and net margin. Since 2012 they have been constantly improving, even during the crisis! Since 2014 the net margin has improved 600 %! This is a clear sign of a company which is turning more and more efficient.

 

The objective of the company is to reach 5 billion SEK by 2021 with an EBIT margin of 7 % - 9 %. However, as mentioned previously, I'd take these objectives with a pinch of salt since they significantly depend on macro-economic factors which are beyond the reach of the company.

 


 

The balance sheet of Ferronordic does not have any significant financial debt and it is a strong cash flow generator. The company presents a current ratio of 1.6 and its current assets are able to fully pay all current liabilities (i.e. it is a net-net company). In general, they have a healthy balance sheet and a very interesting ROCE (>20 %). Good numbers obtained in unfavorable environment.

Valuation

The valuation of the company depends a lot on your personal estimates (and this has to be your own work, don't trust other people's work!) but let's make here an illustrative estimate. Firstly, we assume sales grow to 3 billion SEK, with an operating margin of 7.5 % (conservative figures with respect to company estimates). Then we apply a multiple of 15 and subtract the cash it can have in the balance sheet by that time, resulting in a target price of around 200 SEK.

Summary

Ferronordic is the official Volvo CE dealer in Russia. It is coming out from the recent Russian economic crisis with a strengthened financial position and its stock price is not expensive taking into account all growth opportunities (currently 122 SEK). However, before making any investment decision, it's interesting to summarize they key risks:

  1. Ferronordic has a high dependence with Volvo CE. This dependence is extremely important for Ferronordic (Volvo CE represents 90 % of their sales) and, if broken, it can seriously damage the results of the group. Ferronordic could reduce the risk and weaken it by making other brands a significant part of their sales in the future. Indeed, they are already incorporating new brands to their dealers.
  2. It is a company which has a strong dependence with Russian macro-economy. Investors have to study Russian macro-economy carefully before buying this stock. Ferronordic could weaken this risk by expanding into countries whose economic cycle is not correlated to Russian one.
  3. Ferronordics is trying to maximize the dependence of customers on them through after-sales services. However, this tendency can be weakened if competitors for official Volvo CE aftermarket service appear in the country.

In general, it's an interesting company but you have to be careful before investing in it. Research and do your own work to reach your own conclusions!


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