Salesforce Tower, San Francisco, has 34 Schindler's Elevators
The purpose of this article is to propose a market and financial analysis of Schindler. We use 2 different models to assess the value of the company: (1) the Comparables Method, (2) the Discounted Cash Flow Model.
Schindler (OTCPK:SHLAF, OTC:SHNDY) is a global elevator company listed on the SIX Exchange in Switzerland. It is an important player in its interesting and lucrative market. Products comprise elevators, escalators and moving walks. Competitors include the American and market leader Otis, owned by the conglomerate United Technologies (UTX), the Finnish Kone (OTCPK:KNYJF, OTCPK:KNYJY) and the German ThyssenKrupp (OTCPK:TYEKF, OTCPK:TKAMY).
Sustainable high margins
Schindler’s and its competitors’ businesses can be separated into two parts: (I) New Installations and (II) Maintenance & Repair Services. Volume of New Installations follows the global economy in its ups and downs and margins are around 10%. However, Maintenance is a far more stable and lucrative business with margins ranging from 25% to 35% (source).
Maintenance contracts are often secured at the installation of the equipment. These are mostly long term, providing a recurring flow to elevator companies.
The market is highly concentrated with 2/3rd of the business controlled by 4 companies: Otis, Kone, ThyssenKrupp and Schindler. Now, referring to Porter’s 5 forces model, it means that elevator companies have a strong bargaining power against both suppliers and buyers which are scattered. Moreover, there are barriers to entry: a new company would need to build up a strong network of maintenance mechanics and have a sufficient level of technicity to be reliable before taking business from the incumbents.
Finally, the level of competition between elevator companies seems relatively low leading to sustainable high margins. One example illustrates this well: In 2007, the EU Commission imposed a €992 million fine on Otis, Kone, Schindler and ThyssenKrupp for forming a cartel in Germany and Benelux.
A Growing Market
The elevator market is growing at a nice clip and has a long foreseeable leeway. The reason of that is 3 key “MegaTrends” (to follow Schindler’s terminology) on a global scale: (I) urbanization, (II) growth of the middle class, and (III) rise of the elderly. Let’s review them.
First, urbanization refers to the growth of cities. It is predicted that global urban population will rise to 5.1bn by 2030, from the 4.2bn today. Obviously, cities are where elevators get installed. Secondly, the middle class is growing globally and is predicted to increase about 60% in size by 2030. This is good for Schindler and its peers because middle-class people can afford more living space than the lower class. It means taller buildings and more elevators. Another factor contributing to demand for living space is the rising proportion of single households. Thirdly, the number of elderly is rising globally. It is expected that the number of persons aged 60 and more will reach 1.4bn by 2050. This raises the need for mobility solutions, including elevators, escalators and moving walks.
Predicted numbers are provided by Schindler in its Q4 2018 earnings call slides.
Market analysis revealed that the elevators business is attractive (high sustainable margins) and growing long term. Now let’s try to value Schindler.
First, we have to select public peers to Schindler. Here is the list of public manufacturers of elevators (with the exception of the small companies):
We get a list of 7 companies. 3 of them are focused on the elevator business just like Schindler is. 4 of them are “conglomerates” meaning they have other large businesses besides elevators. We selected the 3 focused companies and added United Technologies from the conglomerate list. Otis is part of United Technologies and a big driver of results for the company, resulting in a fair comparable for Schindler. We do not include ThyssenKrupp because its other businesses drive too much of the value of the conglomerate and would pollute the results.
In the end, selected peers are Kone, Fujitec (OTCPK:FJTCY), Hyundai Elevator (OTCPK:HYEVF) and United Technologies. If we have a quick look at the size of these companies in terms of sales and market cap, we see that Schindler and Kone look very similar, Fujitec and Hyundai are smaller players and United Technologies is a bigger company.
Here are the financials of the selected comparables:
Then we compute multiples:
Finally, we value Schindler:
Note: the PER of Hyundai Elevator is excluded from the computation of the average.
The levered ratios value Schindler at 158 CHF and the unlevered multiples at 191 CHF, for a total average of 172 CHF (using the 7 ratios).
Of course, these numbers should be treated carefully. Fujitec and Hyundai are smaller companies trading at lower multiples. United Technologies has other businesses than elevators. Only Kone is an almost perfect match. But still, we get a rough first idea of the value of Schindler. In my opinion, the unlevered value gives a more precise picture because it takes into account the large cash balance of Schindler.
Discounted Cash Flow Model
Another way to value Schindler is to use a DCF model. So here is a forecast for the next 5 years:
This forecast is built on an estimated 4.5% sales annual growth rate for the next 5 years. This assumption is somewhat conservative regarding the 5-year average sales growth of 5.29% and the market outlook. Another important assumption is a constant operating margin of 9.47% which is a historical 5-year average. Lastly, the Asset Turnover Ratio is set constant at 5.13 which is the 2018 figure.
Here is the calculation of the Cost of Capital:
And finally, we use our forecasted FCF and the WACC to run the DCF model:
The last assumption we made was to use a long-term world GDP growth rate estimate as the growth rate of FCF after 2023. The logic is that Schindler is a truly global company and the elevator business should grow along with the global economy. The world GDP growth estimate is derived from the World Economic Outlook released in April by the IMF. The IMF forecasts a 3.3% and 3.6% growth rate for 2019 and 2020, respectively. We took 3% to be conservative.
The DCF model values Schindler at 227 CHF per share.
Market analysis reveals that the elevator business is an attractive one. It has high margins and produces recurring revenues thanks to the maintenance contracts. The new installations segment provides growth but is subject to the ups and downs of the global economy. The market for elevators is growing and is forecasted to grow further supported by the demographic “MegaTrends.” It’s a concentrated industry with four major players that don’t seem to compete very hard on prices.
The comparables model values Schindler at 172 CHF per share (using the full 7 ratios) and the DCF model at 227 CHF per share. So, we get a 199.66 CHF average and the market price is overvalued by 9.19%.
If you think that using the 191 CHF value estimated by the unlevered ratios of the comparables method is better, the average value (with the DCF) rises to 209.12 CHF, or only a 4.25% overvaluation.
Keep in mind that this valuation is conservative. We view Schindler as a high-quality stock with a moat around the elevator business and a clear path to growth.
We recommend to Hold Schindler stock.
We could also argue a buy recommendation for investors seeking market-level returns.
Disclosure: I/we 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.