All data is sourced from Refinitiv Eikon, unless stated otherwise
Stadler Rail AG (OTCPK:SRAIF) is the third largest rail vehicle manufacturer in Europe after Bombardier (OTCQX:BDRAF) (OTCQX:BDRBF) (OTCPK:BOMBF) and Alstom (OTCPK:ALSMY) (OTCPK:AOMFF).
This article aims to introduce readers to Stadler Rail, which is little known to the public due to the fact that the company has only recently been publicly-listed.
Company background and description
Stadler Rail AG is a leading global producer of rail vehicles.
The company was founded in 1942 when Mr. Ernst Stadler established an engineering office in Zürich, Switzerland. In 1945, the company started producing battery- and diesel-powered locomotives, and in 1962, the first assembly plant was constructed in Bussnang, in the canton of Thurgau. The company entered the production of passenger rail vehicles in 1984, with a focus on custom manufacturing for Swiss private railway companies. Mr. Peter Spuhler, the current Chairman and CEO, joined Stadler in 1987, and subsequently acquired the company in 1989. Stadler made its first key product launch in 1994, with the regional/suburban passenger train GTW 2/6, and subsequently underwent a period of focused international expansion and considerable growth (see Figure 1 in Appendix). This growth was also driven by a number of key acquisitions, including Schindler Waggon's plant in Alternhein in 1997, Sulzer's former Swiss Locomotive and Machine Work (SLM) in 1998, Winpro AG in 2005, Vioth Rail Services in the Netherlands in 2013, and Vossloh's locomotive business in Spain in 2015.
The company was listed on the Swiss Stock Exchange in April 2019, as a result of which Mr. Spuhler reduced his ownership stake in the company from approx. 80% to approx. 45%.
Stadler organizes itself along two main segments:
- Rolling stock: this segment focuses on the design, engineering, and production of high-speed (sold 30+ units to date), intercity (220+), and regional passenger trains (3,100+) and coaches (300+); as well as locomotives (3,200+), metros (300+), and light rail vehicles (LRVs) such as trams (1,000+). As such, the company addresses all segments of the rail market, except for the very high-speed trains (i.e. above 250km/h), and freight wagons (see Figure 2).
- Services & components: this segment offers customers a wide range of services, ranging from the supply of single parts, vehicle repairs, modernization and overhauls, to entire service offerings. Within this segment, the company also manufactures various key components, such as bogies and aluminum & steel car bodies.
Stadler provides its products and services in over 40 countries around the world, centered on the European market, where it has established itself as a leading rail manufacturer. For more than a decade now, Stadler has pursued a strategy of targeted international expansion, with a focus on Eastern Europe and North America, while also being opportunistically active in the CIS region (i.e. former Soviet republics) and certain countries in South-East Asia.
In fiscal 2019, Stadler derived 92% of total revenues from its rolling stock segment, and 8% from services & components. Switzerland, Germany, and Austria (DACH) accounted for 46% of sales, Eastern Europe 43%, North America 1%, and CIS and others accounted for the remaining 5%. Note that because of the project-driven nature of Stadler's business, as well as conservative accounting method (which recognizes revenues very late in the project timeline), the percentages above can fluctuate quite significantly from year to year.
Industry background, competitive position, and barriers to entry
Stadler's strategic markets are clearly defined. The company's rolling stock segment addresses all rail vehicles apart from i) very high-speed trains, which is limited in size, as well as accessibility and/or is dominated by strong incumbent manufacturers; and ii) freight cars, which are less technologically advanced than other rail vehicles and, therefore, more subject to commoditization and low-cost production. Geographically, Stadler further defines its strategic rolling stock market as Europe (both Western and Eastern), North America, CIS, and others; excluding Japan, South Korea, and China, due to significant barriers to entry driven by market protectionism and/or strong domestic players as well as Australia & Pacific.
According to data from studies by SCI, a consultancy firm focused on the international railway and logistics industry, the global rolling stock market amounted to approx. EUR 55 billion in 2017 (see Figure 3). Stadler's strategic market, as described above, was valued at approx. EUR 27 billion and is expected to grow at a CAGR of approx. 5%. Stadler's strategic market for services and signaling technology (i.e. control, command, and signaling (CCS) and passenger information technology) was valued at approx. EUR 6 billion and EUR 16 billion respectively and are both expected to grow at a CAGR of approx. 3-4%.
Based on the company's own assessment, it has a market share of approx. 7% of its global strategic market in 2018. In its home market of Europe, Stadler is the #3 producer after Bombardier and Alstom (which are in the process of merging together) with a market share of approx. 15% (see Figure 4).
We believe Stadler to have a strong market position in its key markets of European countries. Its value proposition to customers is centered on i) engineering excellence and technology leadership, ii) its customization capabilities, and iii) its efficient project management and execution capabilities. We see some barriers to entry related to scale and intangible assets (i.e. brand recognition, technological know-how, and innovation potential).
Fundamental profile
The company having been listed since 2019, we only have financial data from 2016 onwards, which greatly limits our ability to analyse Stadler's financial profile over an entire economic cycle.
Profitability & returns on investment:
Stadler's profitability levels are somewhat comparable to European peers' rail manufacturing segments, with operating margins averaging approx. 6-8%. This is quite impressive, considering its relative scale disadvantage, as well as having part of its manufacturing footprint in very high-cost countries such as Switzerland. Returns on investment are arguably harder to assess, due to the company's business model and accounting methodology. Historically, Stadler ran its business with a significantly negative net working capital, which resulted in high levels of ROIC. Over the past 2 years, however, net working capital requirements have increased meaningfully, which has pressured returns (more on that later). Nonetheless, ROE has remained at a satisfactory level over the past 4 years, above 15%, although it may decline below that threshold for fiscal 2020.
Note: Invested capital calculated as total assets minus cash, minus non-interest-bearing current liabilities (i.e. trade payables and liabilities from work in progress).
Growth:
Stadler has grown revenues at a fast rate over recent years, growing by over 50% between 2016 and 2019. The services & components segment has been growing rapidly, nearly doubling throughout that period, as per the company's strategy. Most impressively, Stadler has continued to win business at a brisk pace, leading to an average book-to-bill ratio of nearly 2.0x for 2016-2020, and a fast-growing backlog of over CHF 15 billion at the end of 2019.
Earnings have grown at a slower rate, as the operating margin was pressured in 2019 due to operational inefficiencies leading to a delay in deliveries for the Great Anglia project, as well as incremental growth investments and FX effects. For fiscal 2020, the company guides for an EBIT margin above 5% due to the ongoing Corona crisis, nonetheless we feel comfortable with Stadler's mid-term target of an EBIT margin of 8-9%.
Cash flows:
Due to Stadler's project-driven business and conservative accounting method (see Figure 4), there are a few moving parts beyond receivables, payables, and inventories to Stadler's operating cash flows. Two of the most significant include net work in progress, as well as compensation claims for work in progress. These can be subject to large swings for any given reporting period, especially in the event of delayed deliveries, or large orders from customers who benefit from more attractive payment terms (e.g. SBB, Deutsche Bahn...). As such, Stadler's history of cash flow generation over the past 4 years is a tale of two halves. While historically, net working capital was significantly negative, net working capital increased meaningfully over the past 2 years and turned positive in 2019. As a result, cash from operations has turned negative, which has drawn on the firm's cash reserves.
Stadler's cash flow woes have not improved thus far in 2020, as the coronavirus has created delays in the homologation and final takeover of finished vehicles. Much of that has likely reversed in the second half of the year, but the Covid situation remains uncertain and new restrictions may be imposed. Stadler maintains that the basic payment modalities of its business model have not changed, and that it will return to a negative net working capital as the situation normalizes. We do not see any reasons for a structural change in payment terms and, therefore, tend to agree with the company's assessment. We return to this crucial point in the valuation section.
Financial position
Stadler has historically maintained a strong financial position. It typically has run its business with little debt and ample cash reserves to manage its business, fund capacity expansion plans, and make acquisitions opportunistically. In 2019, the company did raise some debt to help cope with the large reduction in cash from operations, issuing a CHF 300 million bond maturing in 2026 with a fixed-rate coupon of 0.375%. At the end of 2019, the company had a small net cash position. As of the end of June 2020, total net debt amounted to CHF 417 million or a net debt to equity ratio of 57%. The company is expected to return to a small net cash position by the end of 2020.
Note: all figures are in CHF millions expect ratios
Management team & track record of capital allocation decisions
Stadler is currently headed by Mr. Spuhler as CEO and Chairman of the Board. Mr. Spuhler previously ran Stadler as CEO from 1989 until Dr. Thomas Ahlburg succeeded him in January 2018. However, Dr. Ahlburg's contract was terminated by mutual consent in April 2020, due to diverging views on strategic and organizational development. It appears that at present, there are no immediate plans to find another CEO.
Raphael Widmer is the company's CFO since 2016. Before joining Stadler, Mr. Widmer served as global CFO of the Global High Voltage Business at ABB Ltd. He is a graduate from the University of St. Gallen, holds an MBA from IESE Business School, and is a Certified Public Accountant (CPA).
While we don't have much data to make a thorough assessment of Stadler's past capital allocation decision, it appears that the company has been managed in a way one would expect an owner-operator business to function. That is with a high level of financial conservatism and a focus on strategically-planned profitable growth via organic investments and opportunistic acquisitions. The company's stated dividend policy is to pay out approx. 60% of net income to shareholders annually.
Dividend
Stadler has thus far only paid a single dividend to shareholders as a listed company. For fiscal 2019, a dividend payment of CHF 1.20 per share was made. Past dividend payments, as reported in the Offering Memorandum, are shown below:
Source: Offering Memorandum, adjusted for 1:50 stock spit of 2018
Valuation
A DCF-based valuation yields a fair value estimate of approx. CHF 45 per share or modestly higher than the current share price. We expect sales to grow at a CAGR of 4.7% between 2019 and 2028, operating margins of 7.2% on average, a tax rate of 15%, a WACC of 7.5%, and a terminal growth rate of 2%.
By far the hardest variable to forecast is whether net working capital will revert to being significantly negative in the future, or whether less attractive cash flow generation will continue going forward. Cash from operations has been negative for the past 2 years, which means negative free cash flow and thus worthless shares. However, between 2016 and 2017, CFO/sales averaged 17%. The table below shows the FV sensitivities to various levels of CFO generation, as a % of sales (all else equal).
We currently see the stock as more or less fairly valued, with significant upside potential if our assumptions regarding long-term cash flow generation potential prove overly conservative.
Ownership
Despite going public last year, Mr. Spuhler retains approx. 45% of outstanding shares. Institutional investors own approx. 15% of the stock, while the rest is in the hands of individual investors.
As we've stated in previous reports on such companies, we generally have a positive inclination towards family businesses or an owner-operator model, as it creates a strong alignment of interests between all stakeholders. However, we do believe that it is very important for such businesses to adhere to sensible corporate governance practices and think long and hard about succession planning.
SWOT & red flags
Strengths:
- Solid reputation for quality, punctual deliveries, and customization abilities.
- Flexibility in engineering and production, which enables the profitable implementation of specific customer requirements.
- High order backlog to support future growth.
- Balanced mix of production footprint with over a third of production hours from low-cost countries (i.e. Belarus, Hungary, and Poland), and the remainder in Switzerland, Germany, Spain, and the USA.
Weaknesses:
- Relatively small compared to the industry heavyweights, which could impact innovative potential or ability to win very large tenders.
- FX risk: in certain regions, Stadler is not fully naturally secured against currency risks. The company has key exposures to the EUR, USD, and PLN.
- Customer concentration: between 2014 and 2018, Stadler's largest customer accounted for over 10% of cumulative orders, and the top-10 clients accounted for over 50%.
- Supplier concentration: Stadler outsources the production of most systems and components, apart from car bodies and bogies. As such, it relies on key suppliers for the manufacturing of its products. Its largest supplier accounted for 16% of total material expenses in 2018.
- Late mover in fast-growing signaling technology sector.
Opportunities:
- Gaining market share in signaling technology.
- Establishing itself in the fast-growing US market.
- Digitalization and IoT in services segment.
- Further capitalize on customization experience and reputation.
- The Alstom-Bombardier merger may present opportunities to acquire certain assets from forced sellers.
Threats:
- Cyclical project business, which is also dependent on economic cycles.
- Often highly dependent on government customers and, therefore, of government spending and politics.
- Increased distortion of competition with increasing political support of competitors or protectionism.
- Faster successful rise of the Asian competition (especially CRRC) than expected in the core markets.
- Uncertainty about how strongly Stadler is affected by the COVID-19 pandemic going forward.
Initial conclusions
Stadler is one of the leading suppliers of rail vehicles for passenger transport in Europe, the world's largest market for trains. The global market for rail vehicles is expected to continue to grow steadily as a result of population growth and urbanization, increasing demand for rail transportation versus air and road, environmental awareness, as well as rail market liberalization in many countries. For Stadler, further growth opportunities exist in geographical expansion in strategic markets, including the fast-growing U.S. market; as well as services and signaling technologies. Thanks to a record high level of orders on hand and strong order intake, Stadler should remain on the growth path for some time. However, there is some uncertainty about its profitability and cash flow generation levels, following recent financial results. Still, we are willing to give the company the benefit of the doubt for now, and presume that its structurally negative net working capital model remains intact, and that an EBIT margin of over 8% can be achieved mid-term.
We like the company's competitive position and barriers to entry, as well as its financial profile under normal business conditions. The firm is typically run in a financially conservative way and in the best interest of shareholders. We'd be happy to consider acquiring a stake in the company, preferably below CHF 30, but would likely limit position sizing to 2-3% of Fund's assets.
Appendix
Figure 1:
Source: Offering Memorandum
Figure 2:
Source: 2019 presentation
Figure 3:
Source: Offering Memorandum
Figure 4:
Source: Offering Memorandum