SXYAY - Sika: Growth Benefits From Both Refurbishment And New Construction

2023-09-19 22:45:19 ET

Summary

• Sika is a leading construction chemical company with a wide range of products and is driven by refurbishment projects and infrastructure construction.
• The company's growth rate is impressive, with consistent revenue growth and a significant contribution from the Asia Pacific region.
• Sika's active acquisition strategy, including the recent acquisition of MBCC, is expected to generate substantial synergies and boost revenue and cost savings.

Sika AG ( SXYAY ) is a leading construction chemical company that manufactures a wide range of products, including building finishing, concrete, waterproofing, roofing, flooring, sealing, bonding, refurbishment, and more. Sika's growth is driven by both refurbishment projects in developed countries and infrastructure construction in emerging markets. They are actively acquiring similar businesses to expand their operations and become a comprehensive product provider. As a long-term investor in Sika, I confidently assign a 'Strong Buy' rating.

Long-term Growth Ambition

Sika is a true growth compounding company, aiming for annual revenue growth of 6-8%, an operating margin of 15-18%, and a return on capital employed (ROCE) exceeding 25%. Over the past few decades, Sika has steadily expanded its presence in various markets, both in developing countries and developed regions.

Sika's revenue growth rate is impressive, with only one year of negative constant currency revenue growth. Their constant currency revenue growth decreased by just 3.9% in FY09.

Sika's growth rate is driven by several key factors. Firstly, the Asia Pacific region accounts for over 22% of its group revenue, and this region has exhibited rapid growth over the past decade. Their APAC business saw growth rates of 14.8% in FY22, 19.4% in FY21, 12.6% in FY20, and an impressive 35.1% in FY19. The contribution to growth from APAC is significant for Sika.

Secondly, Sika has been expanding its presence in both developed and developing countries. Currently, emerging markets make up 40% of the total group revenue. This strategic expansion into developing countries is well-founded, as infrastructure construction plays a pivotal role in these economies, and Sika's products are widely utilized in such projects.

Lastly, Sika is actively pursuing acquisitions to further solidify its position in the market. Sika has successfully become a market leader in construction chemicals.

Active and Successful Acquisition Strategy

Acquisitions are a cornerstone of Sika's growth strategy, and they have been actively consolidating the construction chemical industry. Over the past decade, these acquisitions have contributed an average of 4.6% to annual revenue growth.

Sika's most significant acquisition to date is the deal with MBCC , valued at CHF 5.5 billion, which was successfully completed in 2023. MBCC is a major player in the construction materials industry, specializing in construction systems and admixture systems. In 2022, MBCC generated CHF 2.1 billion in net sales, accounting for approximately 20% of Sika's group sales.

Sika anticipates achieving CHF 160-180 million in synergies by 2026 from this acquisition. In my view, this strategic move by Sika makes sense, and these potential synergies are indeed substantial. There is significant overlap in their target customer base, enabling the combined business to optimize its salesforce and boost sales productivity. Furthermore, there are opportunities for cost savings in operations, manufacturing, and back-office functions at MBCC. I believe that they are well-positioned to generate both revenue and cost synergies in the coming years.

Recent Results and Outlook

Sika announced its half-year results in August 2023, reporting a 7.9% increase in sales in constant currency, with adjusted operating profits rising by 6.9%. This sales growth is evident across the board, including a 3.2% increase in EMEA, 11% in the Americas, and 10.1% in APAC. Their guidance for the full year suggests revenue growth of over 15% in constant currency. These results are particularly impressive given the challenging economic conditions.

In terms of cash flow, Sika witnessed a significant improvement in the first half of the year, generating CHF 316.5 million in operating cash flow, compared to just CHF 39.7 million in the previous year.

Sika maintains a robust balance sheet, with a gross debt leverage of only 2x in FY22. This leverage has remained consistent and stable despite their active acquisition strategy.

Looking ahead, as Sika begins to integrate MBCC, I believe they have the potential to improve margins and realize both revenue and cost synergies. These synergies could significantly boost Sika's top-line and bottom-line growth in the future.

Risks

As previously mentioned, Sika derives 40% of its group revenue from emerging markets. It's important to acknowledge that these emerging markets can be susceptible to volatility in terms of new infrastructure construction cycles. While I have a strong long-term confidence in the growth prospects of these countries, it's also essential to recognize the potential for growth volatility. If these emerging markets experience a slowdown, Sika may face a period of slower growth.

On a positive note, Sika's business in developed countries can provide some stability to their earnings growth. According to their management, 80% of their sales in developed countries are tied to refurbishment and repair. These demands for refurbishment and repair are highly resilient and typically cannot be deferred.

Valuation

As the MBCC acquisition has already been closed, I am incorporating the MBCC deal into Sika's financial statement projections. For revenue growth in FY22, my assumptions are largely in line with the company's guidance: 15% revenue growth in constant currency with the inclusion of MBCC business and 6-8% growth excluding MBCC. In the following years, I am using a 6% organic growth rate, which is the average growth rate over the past decade. Additionally, I assume acquisitions will contribute approximately 3.7% to revenue growth. The acquisition growth is projected based on the following assumptions: Sika will allocate 3% of its annual revenue for acquisitions, and these acquisitions will be pursued at a price of 0.8x of revenue.

I also anticipate that Sika's operating margin will expand to 18.1% by FY32, with a corresponding increase in free cash margin to 16.5%. The expansion in operating margin is driven by both operating leverage and the realization of synergies from the MBCC acquisition. As discussed, I expect Sika to capture synergies from both the revenue and expense sides.

In my model, I've applied a 10% discount rate, a 4% terminal growth rate, and a 21.5% tax rate. I've calculated working capital to be approximately 19% of group sales in my model. After discounting all the free cash flows from the firm and adjusting for cash and debts, my estimate suggests that the fair value of the stock price is CHF 287 per share. This valuation indicates that the stock is undervalued.

End Notes

In short, Sika is a well-managed construction chemical company, and I believe there are no similar US-listed companies with comparable business operations. Given the undervalued stock price, I confidently assign a 'Strong Buy' rating.

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