Semperit Offers Real Value In Obscurity

| About: Semperit Ag (SEIGF)
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Semperit is among the market leaders in all of its major business lines and has an enviable track record of double-digit ROIC.

Substitution and over-capacity are two long-term risks, but Semperit has a competitive cost structure and strong customer relationships.

A small float and very low volume likely contribute to undervaluation, as the shares appear 35% undervalued on mid-single digit revenue growth.

(Editors' Note: Semperit AG trades on the Vienna Stock Exchange under the symbol SEM.VI, with ~290K average daily volume).

You might not think there would be all that much to like in an obscure Austrian manufacturer of rubber and plastic products, but Semperit (OTCPK:SEIGF) (SMPV.VI or SEM.VI) is definitely a case where investors should take a much closer look. Rubber gloves, industrial hoses, and conveyors may not sound like attractive markets, but Semperit has managed to generate double-digit returns on capital and respectable margins on a pretty consistent basis. Semperit shares appear to be at least 10% undervalued on a low-ball EV/EBITDA basis, while a DCF model suggests a fair value over 35% higher than today's price.

Semperit is going to be a little more challenging to buy than the average stock. The company offers ample information in English, but the ADRs are not at all liquid. While I normally have no problem turning to a company's home European market when U.S. liquidity is insufficient, the average volume in Vienna is scarcely better with an average volume of less than 8K shares per day. I certainly believe some of the value here is a byproduct of the illiquidity and investors have to appreciate the risk that a speedy entry/exit with no slippage may be difficult.

Core Competency In Multiple Large Fields

Semperit is a nearly 200 year old company with a long history in industrial rubber and plastic products. Semperit is among the largest manufacturers of rubber gloves, industrial and hydraulic hoses, specialty conveyor belts, and assorted rubber/rubber-like products including escalator handrails. The company has 22 production facilities around the world and employs around 10,000 people, with 70% of those working in Asia. Semperit has its own synthetics processing facilities and sources natural rubber through a joint venture with Thailand's largest collector and processor (Sri Trang Agro).

Sempermed is responsible for about half of the company's revenue and around one-third of segment operating profits. Sempermed is the fourth-largest glove manufacturer in the world (by value), holding 10% share in Europe and around 8% share worldwide. Unlike major rivals including Top Glove and Supermax, Sempermed is able to sell a large percentage (nearly half) of its gloves as branded, value-added products (most of its rivals sell commoditized products on an OEM basis). Around one-third of the company's output is in nitrile gloves, a rubber substitute that is safe for those with latex allergies.

Semperflex is the next-largest business, generating around 20% of revenue and 30% of group operating profits. This is Semperit's hose business, including both hydraulic (60% of sales) and industrial hoses. The applications for these hoses run the gamut - from hydraulic hoses in large earth-moving equipment to hoses for steam or compressed air. No end-market or customer makes up more than 10% of the business and Semperit boasts multi-decade relationships with many of its customers, a byproduct of strong product development and reliable manufacturing/product performance. Semperit's hose business isn't so large in the Americas, but is the number three or four player worldwide in hydraulic hoses.

The Sempertrans business is focused on conveyor belts, but particularly steel-reinforced belts used in high-end niche applications. Whereas Fenner (OTC:FNERY) is relatively weak in steel belts (and stronger in woven and rubber belts) and Continental (OTCPK:CTTAY) and Bridgestone are broad-based suppliers, Semperit holds roughly 6% share with a focus on specialized, higher-margin applications.

Last and not least is Semperform. This business is sort of a collection of odds and ends, including window/door profiles, moulded products, and handrails for escalators (where the company is #1 in the world). This business generates about 15% of the company's revenue and nearly 20% of profits.

Competition And Substitution Are Threats

I see two major sources of risk for Semperit - oversupply in the rubber glove market and substitution across its portfolio.

The exam glove market is growing pretty good underlying growth as use expands in emerging markets, but companies like Top Glove, Supermax, and Kossan Rubber have been adding a lot of capacity, leading to consistent mid-to-high teens price pressure. Semperit has been able to offset this with volume growth driven in part by product quality/differentiation and its higher mix of nitrile gloves (which carry premium pricing). Even here there is a risk, though, as Kraton Performance Polymers (NYSE:KRA) is actively marketing its Cariflex synthetic latex as an alternative.

Kraton and other companies like Dow (DOW) that are developing various styrenic block copolymer and/or olefin block copolymer products do constitute a threat to Semperit in my view. Many of these products are developed and marketed with the stated goal of replacing natural rubber or synthetics (like PVC) in applications like hoses and they boast advantages in flexibility, heat resistance, compression resistance, and so on.

SBCs and OBCs have been around for a while, though, and those stated advantages often come with a much higher price tag. Remember too that Semperit does develop its own synthetics and hybrid products and works closely with customers to develop products that meet both performance and cost demands. Just to be clear, I'm not suggesting that Kraton or Dow will become direct competitors with Semperit; rather, the risk is that one of Semperit's competitors adopt new polymers produced by Kraton, Dow, et al, and gain share with the resulting products.

It's also well worth noting that Semperit has plenty of competition in its regular business lines. I've gone over the competing glove companies previously, and Semperit sees the likes of Eaton (NYSE:ETN) and Parker-Hannifin (NYSE:PH) in its hose business, as well as Continental which competes not just in conveyor products, but hoses and "miscellaneous" products as well. There's no particular mystery to the competitive dynamics in most of these business - product performance characteristics, combined with pricing and long-term relationships, are often the determining factors. While Continental is very much a competitive company in Europe alongside Semperit (which generates more than 60% of its revenue in Europe), Eaton and Parker-Hannifin are relatively more competitive in the Americas.

More Threats, And Opportunities As Well

In terms of other threats and risk factors for Semperit, the company's low free float is definitely a factor. B&C Semperit Holding GmbH owns about 54% of the shares and with Legg Mason owning another 10% to 11%, only about one-third of the shares outstanding are truly free-floating. With low liquidity, Semperit is basically off-limits to many larger investment funds and not as attractive of a coverage candidate for sell-side firms.

By virtue of generating about half of its revenue from industrial applications and 60%-plus of its revenue in Europe, Semperit is also vulnerable to overall economic activity in Europe. That doesn't seem so bad now that Europe appears to be on the road to recovery, but those roads are famously winding and bumpy.

Speaking of geography, Thailand is once again in the news due to political unrest. Political unrest has been an unfortunate part of the Thai landscape for some time now and rival parties have generally managed to keep their squabbles from seriously damaging the country's export industries. Still, there is at least a theoretical risk that more serious disturbances could interrupt the company's rubber sourcing JV and lead to higher costs and/or input shortages.

Capacity and margin erosion are also threats to the story. Back in March the company said that it was effectively maxed out in terms of industrial capacity, and capacity additions for operations like the hose business won't come online until 2015. Capacity utilization is also creeping higher in the glove business - good for overhead leverage, but at the cost of potential share/volume growth. Margins are also a potential risk factor; supply shocks to rubber and petrochemical feedstocks would undermine margins and the company's largest business (gloves) is the lowest-margin business.

Against those threats and risk factors, I see a lot of good things about this company. Improving industrial demand in Europe and the U.S. (as well as Asia) should support sales growth in these operations, all of which have substantially higher margins than the glove business. I also like the company's ability to "high-grade" its glove business and carve out share in higher-margin segments. I would also point out that Semperit has a pretty good record of high single-digit to low double-digit margins and low double-digit returns on capital - usually a mark of quality operations.

Modest Growth Is Good Enough

I'm looking for Semperit to grow revenue at a long-term rate of around 5%, with gloves likely outgrowing industrial. I expect growth on the industrial side to develop more or less in sync with industrial activity, as I don't see all that many opportunities to add hoses or conveyor belts where they don't already exist (though belts could be a growth opportunity in areas like Asia where mining and industrial processes have historically used less automation). On the glove side, I think Semperit's growth comes largely from quality/product performance advantages.

I don't expect much in the way of major margin improvements, as Semperit already runs a pretty efficient business and gains in margin may be capped by competition and substitution threats. Increased sales of nitrile and other higher-value gloves could offer some upside, but the looming threat of significant capacity additions leading to further price erosion is real, as is the risk that growing the glove business will compromise Semperit's overall margins. On a more positive note, Semperit's industrial businesses have always offered higher margins. While -flex, -form, and -trans already produce good margins relative to the company's historical performance, rising sales here will help the margin mix and offset some of the pressure from gloves.

Semperit has had a somewhat erratic FCF history, due in part to volatility in asset turnover led by capacity additions/absorption and movements in inventory needed as a result of a large and diverse SKU count. Over the past five years, the company has averaged a little under a 7% FCF margin, with recent years above that average (7.8% and 9.6%). While the recovery in Europe's economy could lend support to higher FCF margins in the near term, I expect the need for additional capacity and inventory (as well as more glove sales) to limit FCF margins to around 7% in the short term and closer to 8% over the long term, supporting a fair value above EUR 53/share (around $72.50) today.

The Bottom Line

Corroborating a EUR 53/share price target with EV/EBITDA is a little challenging. A multiple of 6x would seem appropriate relative to the company's history and sell-side forecasts for EBITDA growth, with growth targets on the lower end around 5% to 6%. On the other hand, the company's competitors and peers in gloves (Top Glove, Supermax, et al) and industrial applications (Parker-Hannifin, Fenner, Trelleborg) all carry EV/EBITDA multiples in the high single digits or low double digits despite generally weaker margins and ROICs.

A 6x multiple would suggest a floor fair value of about EUR 43 ($59), but I think EUR 53 ($72.50) to 57 ($78) (or 7.5x to 8x forward EBITDA) is more appropriate given the multiples on the company's peer/competitor group and the company's margin, ROIC, and competitive positioning compared to that group.

I know some readers will balk at the idea of investing in a thinly-traded Austrian manufacturer of rubber gloves and hoses, but I believe value is value … and I believe Semperit offers a lot of value at these levels. Competitive substitution is a long-term risk to monitor, but I believe Semperit is well-positioned to leverage a global industrial recovery and ongoing growth in its glove business into good cash flow growth and a respectable dividend payout.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.