2023-09-16 10:40:00 ET
Summary
- Legrand, a specialist in electrical and digital building infrastructure, reported a 4.9% revenue increase in the first half of the year.
- The company's strong cash flow generation and low debt position contribute to its robust financial performance.
- Legrand expects to see further growth in the second half of the year and continues to pursue acquisitions to consolidate its market position.
Introduction
Legrand (LGRVF) (LGRDY) is a specialist in electrical and digital building infrastructure with a very strong position in the low-voltage residential construction segment. Although the company started out as a porcelain workshop, it soon specialized in electrical equipment and material right after the Second World War. Its 300,000 products are currently sold in approximately 170 countries while it has actual operations in 90 countries. Its patent portfolio contains almost 4,000 patents.
The company focuses on organic growth and invests a substantial portion of its revenue in R&D (resulting in the aforementioned amount of patents) to ensure it remains a preferred supplier for the construction industry. Additionally, the company deploys its very strong cash flows to acquire smaller competitors and it completes about 4-5 acquisitions per year.
Legrand has its primary listing on Euronext Paris where it is trading with LR as its ticker symbol. There are currently 265M shares outstanding, resulting in a market capitalization of 23.5B EUR based on the current share price of 88.7 EUR. As the average daily volume in Paris is 380,000 shares, investors should focus on the primary listing and avoid less liquid secondary listings.
A strong market position results in strong cash flows
It's not really a secret the construction market is pretty weak these days, but Legrand put in a "solid performance" as it reported a 4.9% revenue increase which would have been 6% excluding the FX changes. The company appears to be pretty pleased with this result as it acknowledges the building market is contracting .
The total revenue indeed jumped to just under 4.3B EUR , and surprisingly, the total cost of sales actually decreased during the first semester: Despite the 5% revenue increase, the COGS decreased by approximately 1.5%. That's excellent to see and even the 9% increase in G&A expenses did not slow down the operating profit increase, which jumped by 13% despite that G&A uptick and the higher R&D expenses.
The company also was able to sharply reduce its net finance expenses from 37.6M EUR to approximately 9M EUR. This is mainly caused by the company's relatively low net debt position (2.4B EUR) with in excess of 90% at a fixed interest rate. This means the interest expenses will only gradually increase upon refinancing the existing debt. Additionally, the balance sheet contains almost 3B EUR in cash and as the interest rates are increasing, Legrand is now actually making some money on its cash pile. I expect the interest income to continue to increase and the net finance expenses to decrease as the company has in excess of 2B EUR of bonds outstanding with a cost of debt of 1% or less. This excludes the 400M EUR of 0.5% bonds which will mature in a few weeks.
The company appears to be very well managed and the balance sheet risks appear to be low. The strong operating expense and excellent cash management resulted in a pre-tax income of 880M EUR and a net income of 651M EUR which was almost entirely attributable to the shareholders of Legrand. This represented an EPS of approximately 2.45 EUR per share.
In my previous article, I was quite surprised to see the company's strong cash flow generation, and that situation hasn't changed yet. The total operating cash flow in the first half of this year was 893M EUR which includes a contribution of approximately 29M EUR from changes in the working capital. Legrand did not specifically mention lease liabilities, but looking at the breakdown of the financial liabilities, the annual lease liabilities are approximately 70M EUR, so I will adjust the operating cash flow result for 35M EUR in lease payments incurred in the first half of the year (the H1 lease amortizations were 37.1M EUR but there is some variation between semesters). This resulted in an adjusted operating cash flow of 829M EUR.
The total capex incurred in the first half of the year was approximately 80M EUR (including the capitalized development costs) and this compares very favorably to the 137M EUR in depreciation and amortization expenses incurred in the first semester (this excludes the lease amortizations).
Deducting the 80M EUR in capex from the 829M EUR in adjusted operating cash flow results in a net free cash flow of 749M EUR. Divided over the current share count of 265M shares, the adjusted free cash flow per share was approximately 2.83 EUR. That's higher than the reported net income due to the difference between depreciation and amortization expenses and the actual cash capex incurred in the first half of the year.
That's a very respectable result but Legrand expects to do better in the second half of the year. It's now guiding for a full-year revenue growth of 5%-8% (which compares favorably to the 4.9% revenue growth in the first half of the year). Additionally, the adjusted operating margin should come in at 20.5% of the revenue (this will be lower than in the first half of the current financial year).
Taking the slightly higher revenue at a lower margin into account, I expect the full-year free cash flow result to come in at approximately 5-5.25EUR per share as the higher interest income should offset a portion of the margin contraction. The EPS will likely be a bit lower, at approximately 4.5 EUR per share as the second half of the year is traditionally a bit weaker than the first semester.
Legrand spent just under 50M EUR on M&A and I expect the company to continue with its pursuit of small bolt-on acquisitions . The markets it's operating in are still very fragmented and Legrand estimates that about half of its addressable market is served by 3,000 small or medium-sized companies. And that paves the way for a strong and cash-rich consolidator to roll up smaller competitors which is exactly what Legrand has been doing in the past decade.
Investment thesis
Although the company isn't very cheap based on its current share price, which indicates it's trading at about 20 times earnings and a 6% free cash flow yield while the current EV/EBITDA ratio is approximately 12, I like Legrand for its low capex requirements and robust free cash flow. And despite the slowdown in the construction sector in the first half of the year, the company continues to grow, and its strong cash flows allow it to acquire smaller competitors.
I currently have no position in Legrand and rate the stock a "hold" right now. I'm keeping an eye on the option premiums but the low volatility levels also mean the option premiums are relatively low. A P80 for December for instance offers a premium of just around 1 EUR, so I am in no rush.
For further details see:
Legrand: A Quality Company, But A Bit Pricey At The Moment