A mechanical engineering company rich in tradition and headquartered in Zurich, Klingelnberg has two production sites in Germany along with distribution and service units in ten further countries around the world. It is viewed as a market and innovation leader in machinery for the processing and testing of gears, i.e. toothed cogwheels, as used in drive trains and other power transmission systems of all kinds. The conglomerate is represented by three key brands: Oerlikon (for bevel gear technology), Höfler (for cylindrical gear technology) and Klingelnberg (for precision measuring centres, drive technology and customized bevel gears).
The company acts as an integrated systems provider, not just on the product side but also when providing services to facilitate the efficient use of products. The latter includes commissioning, maintenance contracts, production support, calibration, provision of replacement parts and repairs, the general overhaul and technical updating of older systems, a grinding service for associated tools, as well as data management and training. A substantial research and development unit with more than 200 employees ensures that client needs feed through into new applications, products, and services on an ongoing basis. Headcount most recently stood at 1,217 employees.
New gear technologies for new customer requirements
The applications of Klingelnberg’s gearing technology cover a huge spectrum of business activities. These include drive trains for cars and commercial vehicles, rail operations, mining technology, industrial operations, agriculture, aviation, maritime drive technology, mill gear units, the oil and gas industry, racing gearboxes, the robotics industry, e-mobility, as well as wind power and other forms of renewable energy. Some areas of the customer portfolio are in constant flux: Even electric vehicles require toothed gearwheels – albeit not those used in traditional drive trains.
Alternative combustion engines reliant on power sources such as hydrogen, biogas, and other biofuels not based on crude oil likewise require similar components to the traditional combustion engine, which has now passed its heyday. However, the company is rather secretive when it comes to revealing the proportion of sales accounted for by these new technologies. It does at least divulge that this area is «significant» to the point where it apparently more than compensates for the loss of traditional clients – and with the added bonus of higher margins. Unfortunately, these future-oriented technologies are hidden away within the various business segments with very different weightings in each case.
Slow to respond to structural change…
As previously reported, Klingelnberg has disappointed investors many times in the past by missing its own overoptimistic forecasts, and while the company has been reporting rising order intakes these have contrasted with declining sales and (since 2019/20) operating losses amounting to almost nine percent of sales. To some extent these can be explained by a number of external developments: Neither the COVID pandemic with its subsequent disruptions to supply chains, nor the flooding of the Hückeswagen production and logistics site, nor indeed the Ukraine crisis were events that could reasonably be expected to have been factored into business development scenarios.
But these events aside, the company’s struggles have led some observers to question whether the company is adapting to changing markets with sufficient rapidity. Whereas the 2021/22 financial year saw sales remain constant, flood damage repaired, and the affected sites reconstructed and significantly expanded, the first half of the 2022/2023 year appears to reflect more than just a return to normality and the processing of a jammed order pipeline. In terms of regional breakdown, 40% of the company’s sales relate to EMEA, with a strong focus on Germany and Switzerland, 42% to APAC, and 18% to the US, where Klingelnberg locks horns with powerful local competitor Gleason-Pfauter.
…or is it a case of “the right products at the right time”?
As a result of the COVID pandemic, a whole slew of sectors essentially suspended their investment activities. The ensuing catch-up effect in areas such as aviation, raw material extraction, and shipbuilding is now accordingly leading to full order books. A good example of this is the energy supply sector, which is in full (Ukraine-related) crisis mode and urgently ramping up capacity everywhere in the extraction, transportation, and processing of fossil fuels. At the same time, new and innovative in-house developments – such as the company’s precision measuring centre for wind turbine gears measuring up to 1,520 mm in diameter and weighing up to 8,000 kg – are experiencing high demand.
China in particular is contributing to the strong growth of the areas of the company that supply products for regenerative energy production. In addition, high-profile project orders acquired by the company in the e-mobility area show that Klingelnberg’s solutions are valued by the market. As at September 2022, the record-high order backlog corresponded to an amount of EUR 286 million – 1.8 times the sales revenues of the two previous full financial years. Even taking the sales figure for the six-month period of April-September 2022 – up 150% year on year – as the basis, the existing order backlog would be enough on its own to ensure full capacity utilization for more than a year.
How future-proof are gear grinding and testing machines?
Essentially it makes no difference what power source a gearwheel is transferring. With constructions based on the latest state of technology, the efficiency of power transfer can be improved and valuable energy saved, irrespective of the source. Even in areas where a changeover of energy source would make little commercial sense in the short term, energy-efficient design can at least partially mitigate secondary effects until that moment comes. Technologically speaking, this is both challenging and tolerance-sensitive – all pretty high-tech stuff. Sustainability in a resource-preserving sense can also be achieved by ensuring that construction parts have long lifecycles and low maintenance requirements, and by overhauling and modernizing older systems to incorporate modern sensors and electronics.
Thanks to the rapidly growing need for e-mobility, Klingelnberg can acquire new clients such as e-vehicle suppliers, while mining companies require any number of precisely manufactured and tested gearwheels to extract the lithium, copper, and cobalt they need to fuel the process of energy transition. Klingelnberg has placed its strategic focus on the area of sustainable energy generation and e-mobility, but nonetheless remains an upstream provider of products to key suppliers in the area of traditional combustion technologies.
Sharp fall in balance sheet reserves
Cumulative operating losses of EUR 46 million over the last three full business years and a further EUR 25 million to rectify uninsured flood damage and expand the Hückeswagen site have taken a toll on the company’s capital position. As of September 2022, total equity amounted to EUR 109.4 million, largely unchanged from the previous reporting date and equivalent to an equity ratio of 39.3%. But this figure was in much more reassuring territory at the time of the IPO, namely around 60%. Even the pleasing half-year figures, which showed sales revenues were two and half times those of the prior year, were not enough to return the company to the black for the period in question.
One of the reasons could be the lopsided nature of the company’s financial year, which essentially sees sales follow a one-third vs. two-thirds pattern in the different halves of the year. As a result, considerable uncertainties complicate the forecasting of business development in the current financial year – never mind future financial years. But even based on the company’s own guidance for the 2022/23 financial year, namely an EBIT margin of «6.0% plus x», a huge improvement in profitability looks to be on the cards.
Long-term shareholders can hardly have been thrilled with the performance of their investment since Klingelnberg floated on SIX back in the summer of 2018. From the all-time high of CHF 55 recorded back then, the price has since slumped by more than 70%. The structure of the shareholder base is particularly worthy of note: 53.5% of the 8.84 million shares are in family ownership and 15.5% are held by funds, leaving an effective free float of just 31%. The announcement of a corporate action would come as a surprise, as the interests of the Klingelnberg family, other major shareholders, and management appear to be closely aligned.
Finding a peer group for comparisons
- With its global workforce of 2,200 employees, the US company Gleason-Pfauter is likewise considered a market leader but was withdrawn from the public capital market following an MBO in 1999.
- The Wallisellen-based company Reishauer, which trades on the OTC market, focuses on gear grinding machinery and accessories, which still form part of the Klingelnberg product universe. Reishauer subsidiary Felsomat produces assembly lines for the construction parts of electric engines, i.e. targets the same customers as Klingelnberg via a different route.
- The much larger Japanese competitor JTEKT (headcount: 43,500) offers a much more comprehensive spectrum of products and services under the Toyota brand, and has a market capitalization of CHF 2.3 bn.
- The listed company Starrag Group, which is based in Rorschacherberg, has a not dissimilar market capitalization to Klingelnberg (CHF 178 million vs. CHF 140 million), and generates just under CHF 300 million of annual sales with a workforce of 1,316 staff. There is some overlap between the customer bases of the two companies, but the machines sold by Starrag and its numerous subsidiaries have a wider potential scope of application (or to put it another way: are less specialized).
Not impressing on the ESG reporting front
In addition to much-needed transparency in the identification of the commercial repercussions of targeting both new and traditional technologies, the company is also something of a laggard when it comes to meeting modern standards in the area of sustainability and ESG reporting. Nowadays, investors and customers typically expect a company to define specific climate targets, provide certain key metrics such as Scope 1, 2 and 3 emissions, and review the progress it is making in the attainment of its targets. With this in mind, Klingelnberg’s reference to its ISO-14001 certification is not terribly illuminating. Similarly, for the company to simply state that none of the products it sells contain substances described as particularly concerning in the REACH Regulation drawn up by the European Chemicals Agency (ECHA) would appear to be a case of meeting the bare minimum of requirements.
This makes it all the more welcome that the company has taken an important first step by signing up to the «Blue Competence» initiative of the association for the machinery and equipment manufacturing industry in Germany and Europe (VDMA), which involves Klingelnberg committing to industry guidelines in the area of environmental and economic activity, as well as social responsibility. Another aim of the VDMA initiative is to raise awareness of the industry’s sustainable solutions that facilitate new energy concepts, the efficient use of scarce resources, and an improvement in quality of life.
Summary
In the previous two financial years, 35% to 38% of annual sales were booked in the first half of the year. In the absence of any nasty surprises and based on the conservative assumption that this figure will rise to 40%, this would extrapolate to a sales figure of some EUR 345 million for the current financial year. Applying an analogous calculation, the existing, yet to be corrected company forecast for an EBIT margin of 6% (with no addition – we view the «plus x» as appropriate, i.e. uncertain) results in an EBIT figure of roughly EUR 21 million. Based on prior-year figures, and assuming that the interest burden will be slightly higher and the tax burden slightly lower (thanks to loss carryforwards and new investments), net profit should work out at approx. EUR 15 million, or CHF 1.70 per share. Given a share price of CHF 16, this would equate to a current P/E ratio of less than 10. In other words, significant upside potential would appear to be slumbering in Klingelnberg purely on the basis of comparison with its mechanical engineering peers (P/E ratios ranging between 15 and 25), quite aside from any operational successes the company might deliver going forward. This still leaves scope to incorporate a company-specific valuation discount.
Klingelnberg’s high order backlog together with a rising order intake suggests that the company is on the right path, that its products and services are in demand, and that its healthy foreseeable development in the current business year will not prove an exception. On the negative side, it remains unclear how long institutional investors in particular will remain unfazed by the absence of contemporary ESG reporting, or whether they might turn their back on the shares for regulatory reasons.
NB: The low trading volume calls for discipline when choosing the magnitude of any exposure and price limits.
