A Quick, No Frills Valuation of KHD

KHD Humboldt Wedag International (KHD) has popped a bit since it reported that it would split itself up to two. And as a highly touted suggestion by me at all prices below $14/share, I have been asked by a few to revisit that valuation. Here is my no bones valuation that really considers 0 growth. Please note that the numbers below are either estimates or rounded numbers!

The first thing to point out is that KHD is really like an engineering firm for the most part (the mining segment is quite small comparatively and I'll just be giving a valuation of the engineering segment). For engineering companies the rule of thumb in performing valuation goes along the lines of this: book value, estimate cash flows from backlog, estimate backlog growth, add cash flows to come up with a future book value, and finally discount future book value to today. Remember that engineering firms should have little to no capex, and so is the case here with KHD.

I won't bother with any of the projections stuff until the end - namely the potential for growth in the backlog. What I will do is estimate what the company's backlog will equate to 1) the value added to book value and 2) a projection of cash flows from maintenance and operation contracts.

And so let's begin!

- In 2008 they incurred costs (directly related to progress billed or how much they charge for percentage of completion) of $170 million and earned nothing, I'm assuming this is because of cancellations and other charges they took on their income statement..

- In 2007 they incurred costs of $390 million and about $100 million in profit, about a 25% earnings rate on billings..

- Taking these into account, I believe that going forward they can earn 20% on future incurred costs

- Looking at their current operations I estimate $100 million in incurred costs per year

- Backlog is $600 million, so the life of their backlog is $600mil/$100mil which is 6 years. All my valuations will be projected based on 6 years (I won't discount them back to today)

- Take 20% of $100 mil for 6 years and that totals $120 million in additional book value from their backlog.

- With current book value at $280 million, book value is expected to be $400 million in 6 years

- Since their operations are largely in emerging economies I believe, on average, that the plants they build will earn 10% ROI. $600 million backlog times 10% = $60 million. Off of that $60 million, I think that KHD will ask for 20% of profits for $12 million in revs at 50% margins which will result in $6 million income on the bottom line.

- $6 million times 15 (15x multiple for a stable revenue stream) = $90 million valuation

- Valuation = $90 + $400 million = $500 million, equating to about $16/share value in 6 years.

This valuation includes absolutely NO GROWTH at all. It accounts for no increases in backlog and it does not account for its mining operations. If they grow backlog about 10% a year, their book value in 6 years should increase $50 million plus another $35 million in equity value due to operations and maintenance - making shares worth about $575 million or closer to $19/share in 6 years.

20% in growth per year and shares will see an additional $100 million from engineering and $70 million from operating contracts, making shares worth $660 million or closer to $22/share in 6 years, an annualized return of about 5%. Keep in mind these are pretty conservative numbers. A 20% growth rate in backlog sounds great, but its actually quite conservative if they're completing $100 million of their backlog per year. 20% per year on $600 million backlog is $120 million in new contracts. The net additional backlog is $20 million. It's not unheard of engineering companies to increase net backlog 5-10% a year! At that rate and the share price of this stock can hit $30+. A strong focus on growing economies that need to expand infrastructure (hello India, China, Russia, South America) should allow for continued growth.

Disclosure: Long KHD

Source: A Quick, No Frills Valuation of KHD