Wednesday, December 26, 2018

edding AG

Stock Price: 88EUR / Market Cap: 52.8M EUR / EV: 33.3M EUR
Business Overview
edding AG is well-known in Germany and Europe for its top quality products, namely its permanent markers. Specifically, it is a nano-cap company that develops, produces, and distributes markers & other writing utensils, and visual communication products in Germany and abroad. Its products are in the writing and marking division are used for creative and industrial applications such as for paints, textile, windows, and permanent and paper markers. Within its visual communications segment, the company provides office products like whiteboards and e-screens.

Writing & Marking Segment (73% of sales)
Produces markers and other writing utensils for commercial applications and private end users. Includes industry and office solutions, as well as creative product lines and household markers. Other product lines include those for printing and decorative cosmetics (namely nail polish, branded under edding L.A.Q.U.E). For the industrial markets, its markers are known for their excellent performance. Special aerospace markers have been approved for BAE use (British Aerospace). The company also makes porcelain markers, and metallic & calligraphic pens.

Visual Communications Segment 27% of sales)
This segment is exclusive to the B2B sector, and has end markets in schools and office conference rooms. It operates under the brand name Legamaster, which is responsible for the development of whiteboards and e-screens. Products include flip charts, whiteboards, and presentation boards. In Germany, sales were up double-digits YOY, 10.5%. In Europe. Sales were up 6.2%. Overseas, sales grew by a whopping 36.9%, most of which came from Argentina.

Revenue Recognition
Sales revenue is generated form independent distribution partners, commercial and private end users, traditional wholesale, retail trade, large-scale outlets (supermarkets, DIY stores), mail-order companies, and online distribution channels. Germany is the single biggest market for the company. 44% of the company’s sales come from Germany, and 66% from Europe and abroad.


edding AG is a cash-rich company. As such, it trades 5x FCF, 4x earnings (when excluding cash from market cap), 0.4x sales, and 1x book. Earnings yield 14%, and FCF 22%. The best way to value a company with a huge net cash position is through an earnings power valuation (EPV).

Next year’s revenue was projected by assuming a 2% growth rate, with 8% EBIT margins, normalized. Edding is a company in a declining industry, so we placed a 10x multiple on it, to assume little to no growth. The resultant EPV/share value was 127 EUR. Since the cash on the balance sheet has value (it could be used for future acquisitions or increased dividend payouts to shareholders), we decided to add it to EPV/share to get a total intrinsic value of 155 EUR/share. That number was then discounted to present value by assuming a cost of capital/return rate of 3% annually, and a time horizon of 3 years. Therefore, we expect to get to the target price within 3 years, which is the most Mr. Market would take to value edding AG fairly. This implies an upside of 76%.

Market Environment
The development of German paper, office, supplies, and stationary market has been hit by the progress of digitization. Despite this, edding has been successful at managing the digital transformation while being able to maintain its leading market position (and it shows in their top line, as discussed below). While markers are the mainstay of the business, edding has a division devoted to the development of e-screens and interactive whiteboards.

For being within a declining industry, edding’s top line has been rather resilient over the past 20 years. From 1999-2017, sales have growth 56%, and 36% in the last ten years. Each year has experienced very consistent growth, averaging 5% (with the exception of 2009). Within Germany, the writing and marking division has an average YOY sales growth of 4%. As a whole, the writing and marking division also has an average YOY sales growth of 4%. Its visual communication division within Germany has experienced YOY sales growth of 8%. As a whole, the visual communication division has experienced YOY sales growth of 6%.

In 2017, the German paper, office supplies, and stationary market stagnated, and is now 1% below its 2013 level. The German market experienced a 3.9% decline in the coloring segment, while the global market for interactive whiteboards and e-screens grew in 2017. As for Edding Group, the company sold more interactive displays than in past years, and sees a trend shifting away from interactive whiteboards (which accounts for under a third of units sold) to interactive flat panels.

Financial Analysis
In 2017, edding’s operating margin was 8%, comparable to previous years which ranged from 7-9%. Its net profit margin was 5%, on the lower end of recent years, which ranged from 5-7%. EPS has growth 30% over the past ten years.

In 2017, the company produced ROIC of 13%, ROE & ROA of 12%. 2017 ROIC was slightly lower than the ten-year average of 15%. ROE and ROA were roughly equal to their ten-year averages. For a company in a declining industry, edding is performing very much above average. It continues to be a market leader, and the name “edding” is comparable to “Expo” here in the States.

On the balance sheet, edding’s cash conversion cycle has been steadily increasing. Its DIO is primarily responsible for an increasing CCC. Days inventory outstanding increased by 18 days from 2016-2017. The longest increase took place from 2011-2012, marked by 30 days. Days sales outstanding has also been increasing but by a far less magnitude with 4-5 day increases each year. DPO, on the other hand, has been consistently decreasing. The company pays its supplier much faster than it collects receivables and turns inventory. Inventory turnover is the slowest, about 2x a year. Receivables are collected about 7x a year and payables paid about 13x a year. This shows that the company is too small to take part in factoring agreements, and doesn’t have much power to negotiate with suppliers on terms despite its very liquid balance sheet.

Inventories decreased by 7% in 2017. The company did not give its reasons. However, because there was an equal decrease in raw materials and finished goods (6% each), the company may be preparing to trim production, and reduce exposure to obsolete inventory.

Debt is practically nonexistent at edding. Its gearing ratio nears zero, and its debt to equity is 0.12. Cash covers total debt about 3.5x. The company has deleveraged substantially from 2008, and has been in a net cash position for several years. It decreased gearing ratio from 0.35 and debt/equity from 0.51. In 2008, cash used to cover only half of total debt.

In 2017, EBIT covered interest approximately 30x over. Operating cash flows and FCF covered interest 35x and 29x over, respectively.

On the cash flow statement, depreciation has trailed capital expenditures from 2012-2016, meaning a five-year period of underinvestment. In 2017, depreciation roughly equaled capital expenditures. For reference, 2017 capital expenditures levels are at two-third’s of 2007 cap ex levels. Investment growth has averaged 5% despite several years of negative growth (that below -11%). Edding is not a capital intensive company, but it is underutilizing its manufacturing capacities. What little it invests is maintenance-related, and doesn't appear to be targeting growth.

2017 FCF was approximately 12M EUR, and has tripled since 2007. 20% of FCF goes toward dividend payments for shareholders, and 5% goes towards LT debt repayment. Dividend payments as a proportion of FCF have decreased from 38% in 2007. Edding’s dividend yield is currently 4.3%, but dividends payments still have a lot of room to grow, so the yield is far from being unsustainable. I believe edding’s shares are undervalued, so a 6% buyback would also be a good use of free cash flow.

Is the business susceptible to a cyclical event?
No, edding’s financials are somewhat resilient to a black swan event, such as a global recession. Looking as 2009 as a yardstick, sales fell by 15% and earnings by 44%. Edding had far greater debt levels then, and was able to cover its interest by EBIT approximately 9x. Now, edding is in a very substantial net cash position, and has far better interest coverage as explained in the preceding paragraphs. Even if sales and earnings fell by the same proportion, history has shown that the rebound will be strong (9% growth in sales in 2010, and 83% growth in earnings).

Is the business being disrupted? How are people and culture changing that might effect the business?
As the edding CEO remarked in 2014, “We will be selling the classic edding 3000 20 years from now. But the number we sell will decrease.” While the company does not give a sales break-down by product, edding’s resilience over the past 20 years even with numerous tech disruptions and the rise of tech giants such as Amazon, shows that the company will continue to be around for future decades. The company does not mention Amazon as a threat, even though the company does not currently sell its markers on the website. It will continue to sell its markers through retail channels, and because of its leadership position in Germany and Europe, it is unlikely that the “edding” brand will fade away. As mentioned before, for Europeans, “edding” is synonymous with “Expo.

 While there has been a rise of digital office media, schools and business conference rooms have continued to use traditional whiteboards. In addition to being used for industrial purposes, edding markers are also used for household use and creative applications. The edding marker has been made so that its use isn’t confined to one use. The edding Group is also exploring new channels, such as nail polish. Online reviews based off numerous blogs have cited edding nail polish for its quality and durability, comparable, or even better than Essie on those two characteristics. The only disadvantage they cited was its price.