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Base Intrinsic Value - KHD

|Includes: KHD Humboldt Wedag International AG (KHDHF)

 KHD (Terra Nova + KID)

$13.90 USD

Market Cap $420 M USD

Introduction

This KHD analysis is to find an appropriate low end price for the shares.  I will analyze only the main hard assets on the balance sheet including commodities, equities and cold hard cash.  This is an attempt to put a low end on KHD’s valuation.  This assessment excludes the additional value from the operational side of KHD (i.e. historical earnings from operations, increased value of Iron Ore, new recurring services revenue to the Industrial business, accretive capital allocations by Mass Financial).

 

Company Background

(According to their website: http://www.khd.com/)

KHD (NYSE:KID) can trace its origins back to 1856. Today KID is one of the leading global cement plant and equipment suppliers. In addition KID provides services such as designing and engineering, project management and supply, as well as supervision of erection and commission of cement plants and equipment. Customer services such as supply of replacements parts, plant optimization and training of plant personnel complement KID’s services. 

The company has its headquarters in Cologne, Germany and functionally operates worldwide via four Customer Service Centres in India; the Americas; Europe, the Middle East and Africa  and Russia/CIS. KHD also has operations in Asia Pacific, China and Australia. The KHD Group has more than 700 employees worldwide.

Terra Nova is the second business, which operates as an Iron Ore Royalty company.    Terra Nova will focus on the acquisition of existing mineral royalties; providing capital for the exploration, development and construction of iron ore and other metals mines in exchange for royalties.

 

 In early January, the company announced plans to increase shareholder value by splitting the two operations into separate entities Terra Nova and KID. 

 

Assessment

 

Recently, a highly anticipated consolidated financial report was released by KHD.   The report had numbers which did not seem consistent with expectations.

The report confused me and I felt as though my estimates weren’t accurate or I had been mislead by management. This was shocking because I trust and respect the management team.

After reassessing my research and the available KHD material, I’ve concluded the following:

 
1) The KID reported numbers apparently 
DO NOT include many, if any, of the newly added divisions (i.e. INDIA, South Africa, Australia). 
 * I expect solid order flow from these divisions for the foreseeable future.

2) Servicing revenues were not added to the projections.
* I expect the 500 plants built by 
KHD to immediately start working with KID and this is not added to estimates. This revenue stream is recurring and was not a past source of revenues.

3) Michael Smith will avoid paying taxes at all costs and spinning KID off tax efficiently should have been a given.  It was just not what I expected. 

I believe a common mistake is being made.  Everyone thinks that the KID portion of KHD is going to lose money which is unlikely to be the case.  It doesn’t matter much because the shares would be undervalued even if KID lost twice the amount stated in the report.

 

The Valuation

KID

KID is going to heavily focus on India.  Here is a recent article regarding cement demand in India:

http://economictimes.indiatimes.com/news/news-by-industry/indl-goods-/-svs/cement/Higher-demand-lures-cement-cos-to-build-presence-in-eastern-India/articleshow/5665358.cms

KHD doesn’t make cement. They build / maintain / upgrade the plants for those that do.   So the competition mentioned in the article above will actually be a good thing for companies like KID and FLSmidth.  The more competition entering the market will lead to the need of more plants being built. The increased competition also leads to more upgrades of existing plants.  None of the expected increase in future business is included in this estimate of KHD’s current base valuation.

MFC Bancorp (KHD pre-2006) 2004 Annual Report talks a great deal about India and is a great read for anyone interested in that portion of the world. 

http://media.corporate-ir.net/media_files/irol/92/92949/reports/mfc_ar04.pdf

KID is already TRADING.  It is NO longer a mystery as to the value of this portion of KHD.  All the work has been done for us.  KID has actually traded in Germany for 15+ years.  Only about 2% of the outstanding shares are floated with the rest being owned by KHD.  KHD has a strong background and history in Germany.  The increased liquidity of KID shares should be taken well.  It should also be included into several indexes once the spin is completed.

The current bid/ask is 13.10 x  13.15 Euros.  http://finance.yahoo.com/q?s=KWG.F

KID is going to make a cash dividend to Terra Nova = 2.71 euro per KID share

13.10 – 2.71 = 10.39 Euro in KID value after distribution

30.25 m shares outstanding,  1.3737 dollar = 1 euro

1 KID for every 7 shares of KHD owned = a 26% distribution of KID

4.32857 M shares of KID distributed = 26%

10.39 x 4.32857M = 44,973,842 Euros = 26%

44,973,842 Euros = $61,780,566 USD = 26%

100% = $237,617,564

97.6% owned by KHD =  $231,914,742 USD

$231,914,742 / 30,250,000 outstanding shares = $7.67 per KHD share

 

Terra Nova

Up until 2006 the royalties generated from iron ore were set at a fixed number. The amount ballooned when it was taken off the fixed rate and put on spot rate. The run rate then became something like: 
2007: $18 Million 
2008: $30 Million 
2009 will be lower - somewhere around $13-15 Million 
2010 will be back higher with spot prices trading anywhere above the lows (*prices are considerably higher as of now) 

The value of the Iron Ore is stated at $200 M on the balance sheet.  This value is derived using the following variables : ( iron ore price of $3.70/ton, over a period of 15 years, at 5 tons per year, a 20% tax rate, an 8% discount rate, with 2% escalations )
*Note – these numbers are below current prices

Terra Nova will also have cash of approx $120 M.  (113m stated + royalties that will accrue before a distribution plan is established)

 Terra Nova has an agreement in place with Mass Financial (MFCAF.pk) for the management of the royalties and the allocation of capital.  The capital will be used to generate increases in book value and yield for Terra Nova shareholders.  Mass Financial is run by Michael Smith, who I feel is one of the most impressive capital allocators of our generation.  Mass Financial receives 8% of the royalty generated by Terra Nova.  Smith’s expertise does not come cheap, but his incentives are aligned with shareholders to maximize the royalty stream. If history is any judge, you can almost assuredly place a 1.25 factor on the Terra Nova cash.  Smith has a lengthy track record of market smashing, compounding returns.

For valuation purposes we will go ahead and assign a value of 1.00 on our cash (and assume we will be happy when Smith adds a ton of book value when everything is all said and done).

The mine value ($200 M) is understated but we won’t move that up either.

$200 M mine + $120 M cash = $320 M

I don’t know how you can come up with a lower number.

30.3 Million outstanding shares.

Terra Nova value = $10.56 per KHD share.

I don’t see how this won’t be a floor price.

 

KID  ($7.67) + Terra Nova ( $10.56) = KHD $18.23

 

Conclusion:

My low end assessment for a fair value of KHD is $18.23.  Currently trading at $13.90, KHD offers investors an opportunity to purchase shares significantly below the fair intrinsic value of the company.  Therefore,  I feel KHD offers patient longer term investors a meaningful margin of safety.  While the low end fair value assessment of KHD is $18.23, I also feel there could be significant upside to this number should any number of positive events unfold. 

 

Potential Catalysts:

Spin out of KID

Realization of value in Terra Nova

The addition of KID to one or more indexes in Germany

The initial dividend distribution for Terra Nova

The (likely) immediately accretive investment by Michael Smith for Terra Nova

Contracts from the “razor blade” servicing revenue for KID

 

 

Some additional information:

The KID subs: 

KHD Humboldt Wedag AG, Germany 100% 

Humboldt Wedag India Private Ltd., India 100% 

Humboldt Wedag Australia Pty Ltd., Australia 100% 

Humboldt Wedag Inc., Delaware 100% 

EKOF Flotation GmbH, Germany 100% 

KHD Humboldt Wedag Machinery Equipment (Beijing) Co. Ltd., China 100% 

ZAB Zementanlagenbau GmbH Dessau, Germany 98.2% 

Humboldt Wedag GmbH, Germany 98.2% 

KHD Engineering Holding GmbH, Austria 50% 

KHD Humboldt Engineering OOO, Russia 50% 

OAO Sibgiprozoloto, Russia 50% 

Blake International Limited, Brittish Virgin Islands, 100% 

KHD Humboldt Wedag Industrial Services AG, Germany, 88% 

HIT Paper Trading GmbH, Austria, 88% 

Paper Space GmbH, Germany, 88%

Here are a few of their websites:

http://www.humboldtwedag.co.za/ 
http://www.ekof.de/indexe.html 
http://www.zolotoproekt.ru/ 

 

FLSMIDTH stated 2008 market share for the cement plants in INDIA was: 

FLSmidth = 54% 
KHD = 19% 
LNV = 10% 
L&T = 10% 
Polysius = 7% 

http://attachments.flsmidth.com/CMD_2009/FLSmidth_India.pdf

 

DISCLOSURE:  The author has a position in KHD. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.



Disclosure: Long KHD, Long MFCAF.pk