In February 2023, the latest available figures of mechanical engineering company Klingelnberg were analysed and a forecast was ventured as to where this supplier of e-mobility and energy generation technologies (or in oldspeak: “manufacturer of gear grinding machines”) might be headed. Climate change is also likely to trigger an increased need for gear wheels in the foreseeable future, and Klingelnberg is well placed to meet this with its broad offering. The most recent figures published in June for the period up to 31.03.2023 only strengthen this view.
An end to the economic doldrums?
With its two production locations in Germany along with distribution and service entities in ten further countries around the world, the Zurich-based mechanical engineer Klingelnberg is viewed as the market and innovation leader when it comes to machines for processing and monitoring gear wheels. In addition to drive trains, gears are also required for any number of other forms of power transmission. The group is known through the brand name Oerlikon for the production of bevel gear machinery and Höfler for cylindrical gear technology, while for precision measuring centres, drive technology and job gearing it operates under its own name Klingelnberg. With a workforce of more than 1,200 employees, the company sees itself as an integrated systems supplier that also provides the services required for the efficient use of its gear wheels. These include commissioning, maintenance agreements, production monitoring, calibration, replacement part supply and repairs, the general overhaul and technical updating of older systems, a tool sharpening service, data management, and training.
Order backlog being worked through at full capacity
The company’s process of transformation from its previous product spectrum – which was still focused around traditional industries such as automotive and commercial vehicles, rail industry solutions, mining/materials handling, heavy industry, agriculture, aviation, maritime propulsion technology, crusher gear boxes, and the oil and gas industry – to applications in robotics, e-mobility, wind power, and other renewable energies has weighed on past annual results and given rise to operating losses at times. Extraordinary factors such as the Covid pandemic, supply chain crises, and the war in Ukraine presented further challenges, as did the flood-related outage of the Hückeswagen production and logistics site in the summer of 2021. As is clear from the company’s figures and reporting for the 2022/23 financial year, however, Klingelnberg has put this phase firmly behind it.
Drive trains for e-mobility applications may require fewer gear wheels than conventional combustion technologies, but quality requirements are on the rise and manufacturing tolerances are becoming ever lower – particularly when it comes to ensuring the energy-efficient, quiet, low-maintenance, and long-lasting functioning of the engines built with such gear wheels. As wind energy facilities become ever larger, so too is the demand rising for the necessary new large-scale drive units and corresponding gear wheels, for the production of which Klingelnberg is developing and building new grinding and testing machines.
New records set for sales and order intake
The half-year figures had already fuelled hopes of a tangible recovery – and this turnaround has quite clearly occurred. For example, net sales increased by 95% to EUR 309 million, although to some extent this no doubt reflects catch-up effects following the flood-related outage of the Hückeswagen production site. This development is also reflected in the order backlog of EUR 259.6 million, which is down slightly by 3%. By contrast, the surge in the order intake by 12% to EUR 300.4 million bears witness to a strong demand trend. Despite a 31% increase in absolute terms, the proportion of sales accounted for by services, tools and installations declined from 38% the previous year to around 25% for 2022/2023.
When broken down by region, the most striking aspect is the huge shift towards the Far East. Customers in the Asia-Pacific (APAC) region accounted for 52% of sales, up from 42% the year before, while 31% was generated in the Europe/Middle East (EMEA) following a figure of 39% for the previous year, and the Americas accounted for 17%, down from 19%.
The healthy development of business is apparent across all segments.
- The company achieved sales growth of 87% in the bevel gear segment, whereby a shift in the proportion of sales from the automotive sector to the aviation industry was clearly apparent.
- The highest sales growth of all – a handsome 125% – was recorded by the cylindrical gears segment. Toothed-gear machines for e-mobility and for hydropower installations were responsible for a further shift of the customer spectrum away from fossil fuels to renewable energy sources. Growth here is being driven from customers based in the Far East, particularly China.
- Precision measuring centres were in similarly strong demand, with sales up 89% compared to the previous year. Strong stimuli in this segment came from the transport sector, in addition to the automotive and commercial vehicle industries. The newly launched measuring centre models were received by the market enthusiastically. In industries where manufacturing tolerances are falling and the quality demands of customers are on the rise, the measuring process needs to be correspondingly precise. The combination of optic and tactile measuring procedures makes it possible to carry out measurements both rapidly and precisely – even in the micrometre and nanometre ranges. When combined with gear-grinding machines, testing machines deliver particular added value, as they document the permanent verification of the relevant quality features.
- The growth drivers in the gear box technology segment, which enjoyed a 64% rise in sales, were above all maritime applications such as gear boxes for stern thrusters as well as the crusher gear boxes supplied to the mining industry.
Forecast of “EBIT margin of 6% plus x” comfortably exceeded
High energy prices (ever since the outbreak of the Ukraine conflict) and higher credit interest rates (a later but equally pernicious development) have counteracted the healthy development of results, yet their effects are somewhat concealed by the company’s operating successes. Lower expense ratios in relation to sales, namely 41% for material expenses and 32% for personnel expenses, point to the company’s favourable exploitation of scaling effects as well as full utilization of existing capacity. Research and development expenditure declined from 14.4% to 8.0%, which is primarily attributable to the base effect following the doubling of sales. Special items from the previous year, such as insurance claim payments and state support on the income side, as well as the scrapping of flood-damaged stock on the expenditure side, did not recur in the reporting year.
With a respectable EBIT margin of 8% and a 6.7% return on sales, Klingelnberg is once again in the black following a long period of negative profitability. At EUR 15.7 million, operating cash flow was firmly back in positive territory after coming in at EUR -54.5 million in the previous financial year. It is hardly a surprise that the reconstruction of the Hückeswagen site accounted for the lion’s share of the cash outflow from investment activities, which amounted to EUR 17.6 million. With almost no change in indebtedness, equity capital stood at EUR 126 million on the reporting date, a rise of some 21%, while the equity ratio improved from 38.3% to a comfortable 44.5%. From the net profit of EUR 20.8 million – or profit of EUR 2.35 per share – shareholders can look forward to a dividend of CHF 0.40 (subject to a corresponding resolution being passed at the AGM on 22.08.2023), of which a half should come from tax-neutral capital reserves. The resumption of dividend distributions could well be a sign that the main shareholding family anticipates enduringly positive business development. There looks to be scope for higher dividend distributions going forward given the last dividend payout of CHF 1.00 per share in 2019, with the current payout ratio of 18% likewise appearing to have upside potential.
Valuation discount expands: P/E now below 8
Compared to a P/E estimate of 9.4x back in February 2023, which was based on profit per share of CHF 1.70 and a share price of CHF 16, the stock market is essentially marking down Klingelnberg shares to a P/E ratio of 7.7x, given profit per share of CHF 2.46 and a share price of CHF 19. In other words, the security buffer demanded by the market has actually grown further. One factor behind the discount to the market average could be the ongoing absence of any ESG reporting. The company’s participation in the “Blue Competence” initiative of the VDMA – designed to promote sustainability in mechanical engineering systems building – cannot act as a replacement for this important new component of information provision to the capital market, which is now increasingly becoming mandatory for SMEs too.
That said, the company has at least now lifted the shroud that until recently veiled the proportion of its business volume accounted for by new technologies. Thanks to new orders in the area of e-mobility and above all from leading Chinese wind energy systems producers, the proportion of the order backlog accounted for by customers active in the area of sustainable energy production/use is now well above 50% for both “precision measuring centres” and “cylindrical gear grinding”, which looks pretty convincing. In addition to a “dynamic” continuation of this trend, Klingelnberg is also expecting to receive new orders for products from the mining sector, along with a repetition of its excellent result for the current financial year. Given its strategic positioning, innovative products, cost control, and lean management, the conglomerate believes it has strengthened its position as a global market leader. Essentially this means that Klingelnberg is building the right gear grinding machine for every sector and every industry. The contribution made by the decarbonization of energy production, mobility, and other customer sectors is unquestionable, so it is only logical that the company should be able to supply scientifically-based ESG information while at the same time fulfilling the newly introduced requirements of integrated reporting. This is important because of the company’s activities outside of Switzerland, above all in the EU, where compliance with the EU’s taxonomy and legislation such as Germany’s Act on Corporate Due Diligence Obligations in Supply Chains is now high on the political agenda; hence any non-compliance by Klingelnberg could end up with the company being hit by nasty sanctions. What’s more, such a development would also see Klingelnberg stock removed from the potential investment universe of many institutions for regulatory reasons.
Summary
Regional diversification of both suppliers and customers is a topic already being addressed by the company. And so it should be, as the high proportion of Chinese customers, the influence of global supply chains, and global political convulsions could rapidly have unfavourable repercussions for business development. In view of resurgent profitability and the laggardly pace at which the capital market has rediscovered its confidence in Klingelnberg, it would be regrettable if the company were to be found wanting here. The existing order backlog on its own is equivalent to some ten months’ sales.
Klingelnberg’s dependency on traditional industries continues to fall – providing it with a good opportunity to part company with them in the medium term without any great harm being done. Full capacity utilization together with price increases to match the rate of inflation, possibly complemented by small efficiency increases, point to moderate sales growth of 5% to EUR 325 million for the current year. With an unchanged return on sales of 6.7%, this would equate to a post-tax profit of around EUR 22 million. The stock price has already experienced something of a surge since the company last reported in February 2023, rising by around 22%. Dynamic development is expected from both a fair price level standpoint and with regard to the dividend distribution, at the latest when Klingelnberg finally gets to grips with the theme of ESG reporting.
But one note of caution: The stock’s low trading volume calls for discipline when it comes to both magnitude of exposure and price limits. Just 31% of the 8.84 million shares are owned by shareholders other than the Klingelnberg family and a few key institutions.
