This report is published by Research Dynamics, an independent research boutique


Markedly improved profitability amid pricing pressure


Increased profitability and strong order pipeline ensures sustainable growth
Schaffner reported a healthy set of numbers for the year with net income at CHF8.7mn (vs. CHF0.2mn in FY2016) thanks to significant growth in Europe (+11.4%) and North American (+4.3% y/y) regions. Operational efficiency in the underlying segments managed to more than offset the increased raw material prices that prevailed throughout the year. Management reiterated its target of organic sales growth of 5% and EBIT margin above 8% over the medium term. We believe this target could be achieved due to (1) investments in R&D that focus on EMC filters for electromobility applications and the launch of active harmonic filters in FY2018 (2) a healthy order book ensuring a steady revenue stream for the company going forward and (3) a continued turnaround in the Power Magnetics division should make a substantial contribution in terms of sales and margin improvements. The group's recent proposal of dividend distribution amounting to CHF6.5 per share (new pay-out ratio: 40-50% of net profit) bodes well for the company by showing commitment to the shareholders. Change in top-management at the CEO and COO level is expected to bring about new leadership skills.
 

Revenue growth and considerable progress across segments
Schaffner reported net sales of CHF195.7mn (+5.5% y/y, +6.6% in local currency) for FY2017 largely driven by growth across all segments. It witnessed strong revenue growth in Europe (+11.4% y/y) and North America (+4.3% y/y) while Asia remained flat. In terms of markets, machine tools and robotics business in the EMC division saw good growth (revenue up 40% y/y) and sales for rail technology products in the PM segment grew by 8% y/y. The company's order intake expanded to CHF199.5mn (+6.5% y/y) which provides room for further growth, the book-to-bill ratio increasing a tick to 1.02 (1.01 in FY2016). EBIT grew significantly to CHF11.5mn (vs. CHF1.4mn in FY2016) with an encouraging EBIT margin at 5.9% (vs. 0.7% in FY2016). Net income amounted to CHF8.7mn (vs. CHF0.2mn in FY2016).
 

Segmental performance
EMC: The EMC division is the highest contributor towards the company's sales (50.2% vs. 50.6% in FY2016). Its top line grew 4.7% y/y to CHF98.3mn; largely driven by growth in the number of new customers globally. Power Quality business under EMC segment extended its service and sales network with the launch of second generation passive harmonic filters. Though raw material prices increased (e.g. copper) in FY2017, operational excellence in the EMC segment managed to reduce production cost. Segment profit improved significantly to CHF13.3mn (+52.9% y/y) in FY2017.
 

PM: The PM division accounted for 25.6% (vs. 24.5% in FY2016) of Schaffner's sales in FY2017. Its sales increased to CHF50.0mn (+10.3% y/y) with a reduction in segment loss of CHF7.0mn (vs. CHF 13.8mn in FY2016). Growth has largely come from the US and China. The segment showed signs of improvement post the structural adjustments and establishment of new manufacturing set-up in Europe and North America. In addition, management expects further improvement in the situation with direct supply to OEM manufacturers in North America and attractive business opportunities in rail technology market and electric vehicle market.
 

AM: AM segment revenue expanded slightly (+2.2% y/y) to CHF 47.4mn. However, segment profit decreased by 16.8% y/y to CHF9.4mn with a reduction of 460bps in segment profit margin to a still attractive level of 19.9% (side note: management has always indicated that a >20% EBIT margin would not be sustainable). Demand was lower in 3Q17 especially in North America and South Korea but improved again in 4Q17. Its keyless entry business contributed c.90% in divisional revenue. With several development projects for filter solutions for electric vehicles, AM is building a base for future growth. Management expects that the electric vehicle market should contribute a significantly higher share towards AM's sales in two to three years. Although the AM division achieved a very attractive margin of over 20% in the past years, management now stated that a margin of 15-20% in a maturing keyless locking system market is more realistic going forward.
 

Optimistic outlook
Schaffner management is hopeful about the outlook for the business on account of strong business opportunities in the area of rail technology, energy efficient systems, electric vehicles and electromobility. The company has guided its EBIT margin to be in mid-single digits for FY2018 despite increasing raw material prices and pricing pressure in some of its market segments. Schaffner has reiterated its target of organic sales growth of 5% annually and a minimum EBIT margin of 8% in medium term.
 

Valuation looks attractive based on discount to peers on 2018 estimates:
Based on 2018 median EV/EBITDA estimates, the company is trading at a 19% premium to product peers while simultaneously trading at a discount of 6% to its industry peers. Based on 3-year average EV/EBITDA, the company trades at a discount of 7% to product peers and 5% discount to industry peers. However, we believe the group's improved profitability, strong order pipeline, strengthening in management team and recent multi-year contract wins should help Schaffner to achieve its medium and long-term target (organic sales growth of 5% and EBIT margin of more than 8%). In addition, a turnaround in the Power Magnetics division would have a substantial impact on group sales and margins. The intrinsic price of the group using the DCF methodology (WACC: 6.9%, terminal growth rate: 1%) comes to CHF 348, which corresponds to an 9% upside to the current share price.