Einhell Gruppe AG

Einhell Gruppe (EIN3.Germany)

Price: €35.64 (10/31/11)

I stumbled upon Einhell through a screen I recently ran at FT.com.  I wanted to find stocks that had decent long term operating stats but had been dragged down in Europe as part of the debt debacle.  I ended up with a good list of stocks that aren't superstars, but are consistent operators that have probably been unfairly dragged down.

The first I want to look at is Einhell a Germany tool manufacturer, I'd love to go to Lowes and personally examine the quality of the tools, but they sell their tools everywhere but North America.  Einhell manufacturers all sorts of power tools for remodeling, such as circular saws, reciprocating saws, drills, sanders, lawnmowers, small greenhouses, and air conditioners.  The company's sales are pretty evenly divided between power tools and lawn equipment.

The company's philosophy is to sell quality tools to the recreational user.  I would think a recreational user is the type of person who has to cut at 2x4 maybe two or three times a year for simple projects.  Although I can't examine any of the products myself I'd probably equate Einhell to something like Harbor Freight Tools.  Harbor Freight is great, you can buy anything there cheap and it seems like a panacea until you use the tool more frequently than it was built for and realize it probably would have been wise to pay up in quality.  This isn't to say that those sorts of tools don't have a place, they do, and the place is in most people's workshops.  The reality is that most tools are used infrequently outside of hard core DIY'ers, and professionals.

Valuation

I was able to find 10yr stats for Einhell via MSN Money, so I want to take a look at the company in light of it's historical results, and I also want to consider the margin of safety for an investor.

I want to speak for just a minute as to why the company is selling at such a cheap valuation.  Einhell has fallen in general with the German market, this is the first and main reason for the depressed valuation.  The second reason is with a depressed market there are fears that consumer goods companies will fall as consumers stop purchasing non essential items.

Einhell sells 38% of their products to the domestic German market, they sell 79% of their products in the EU, and the rest in Asia and Australia.  Even with the European debt crisis the company recorded an increase in revenue at the latest interim statement.  Sales have been growing overseas enough to counter domestic declines.  I believe this finally changed in the most recent quarter, but we'll have to wait until November to see how bad the decline is.

Investment Thesis

I think the thesis for Einhell can be summed up quite nicely in the following stats showing that on a number of different metrics Einhell is selling cheaply:

In addition the company has about €139m in working capital against a market cap of €54m which makes it a net-net.  I didn't screen to find any net-net's, these companies are just somehow attracted to me which I thought was an interesting coincidence.

Since Einhell qualifies as a net-net I through the worksheet would provide a good overview of the current balance sheet.

The composition of the balance sheet is heavily weighted towards inventory and receivables which is understandable for a consumer products company.  Liabilities are composed mostly of bank debt and accounts payable.  There is also a provision account of €14m, this account is mostly held for warranty repair work.

Looking at the net-net worksheet I would say the Einhell balance sheet qualifies as a quasi margin of safety.  In a liquidation scenario with discounted receivables and inventory the company would probably fetch around €7 which is a lot lower than the current market price.  The company also doesn't have much cash on the balance sheet.

10yr Balance Sheet

I recently discovered that MSN Money provides ten year income and balance sheet statements for a lot of different international stocks, so I pulled in the ten year stats for Einhell.

A few things stood out to me when taking a look at the historic balance sheet.  The first was that NCAV has been growing at about a 10% clip over the last decade.  A growing NCAV isn't a bad thing if the growth is due to increasing cash balances or a growth in the equity account, this isn't the case with Einhell.  The growth in NCAV is due to increases in receivables and inventory over the years, a growth in both accounts should be expected to stay roughly in line with a growth in sales.  In the case of Einhell sales have been lumpy for the past decade and current assets have consistently grown, this is a caution flag for me.

The second thing that stands out is that Einhell isn't too heavily indebted.  The company has made further progress on this front reporting that they paid down €20m right after the H1 statement.  I would estimate that the current debt load is in the €25m range or so, which is very manageable.

The last thing to note is the increase in shares outstanding in 2003.  Dilution is always a concern for equity investors and can destroy a margin of safety quickly.  The cause for the 2003 dilution seems to stem from the major loss Einhell experience in 2002.  My guess is their capital ratio went negative and they were required to raise capital to remain in compliance with their listing.  

10yr Income Statement

The historic income statement paints a much better picture of the company than the historic balance sheet.  Einhell is a pretty consistent company, they've had sales in the range of €234m to €417m over the last decade and margins have remained pretty consistent.

In terms of current operating performance Einhell is a bit on the high side of history which is good, the H1 EBIT margin came in at 6.7% and net margin at 4.9%.  It's questionable if those margins can stay high considering the possible downturn in revenue for H2.

Cash Flows

When I took a look at the cash flows for Einhell that's when the thesis started to break down for me.  A company can be wildly profitable but if the cash isn't coming in the door the profits are just a fiction.

Einhell has been very profitable in 2010 and H1 2011, yet when I look at the cash from operations it's been negative the entire time.  Where did the cash go?  The cash all went into increases in working capital, mainly inventory and some receivables.  The shortfall from CFO is accounted for in the dwindling cash balance.

I wasn't able to get a ten year outlook on cash flows, so I had to settle with the five year lookback that FT.com provides.  Einhell seems to be pretty volatile when it comes to cash from operations, and in turn free cash flow generation.  They seem to run in streaks where they will build up working capital and then wind it down.  In some years working off inventory provided a nice boost to cash.  The problem is this isn't a sustainable pattern.  I would rather see a company with consistent inventory balances and consistent cash flow verses a bonanza year and then a few lean years.

When I saw the spotty cash flow record I decided to put Einhell's numbers into my accruals worksheet which is basically a quality of earnings spreadsheet.  The accrual numbers for Einhell aren't pretty:

I like to see accruals to be in the 8% and below range for most companies.  At times there can be exceptions but in the case of Einhell this spreadsheet just confirmed my fears from the cash flow statement.

Where is the margin of safety?

I really like Einhell, I don't really like the lack of cash to back up the accounting profits.  The company is selling for less than working capital yet I kept asking myself if a true margin of safety exists.  I think it does, and I think the margin exists higher up the capital structure at the bank debt level.  I would buy Einhell bonds all day, there is adequate interest coverage, and good asset protection.  At the equity level I just don't have the same level of confidence.

Bottom line

Einhell is a company I'd consider owning if the quality of earnings improved, some of the asset balances declined and the cash started flowing.  I am planning on keeping my eye on the company for Q3 results at the end of November.  What I originally thought was going to turn out to be a great investment turned out to be more of a dud with some future potential.  In the case of Einhell the investment decision didn't rest on any problem with the business, it rested with more of a problem with the financials.

Talk to Nate about Einhell

Disclosure: No position