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Morningstar | Activist Investor Gains Seat on GEA's Board; Shares Attractive

We welcome the news that GBL, an activist investor with a 7% holding in wide-moat GEA Group, has gained a seat on the company's board as it should support restructuring efforts from the new management team. GBL representative Colin Hall is stepping in for Werner Bauer, who resigned from the board before the end of his term. Hall will stand for election to a permanent seat next year in April. Based on our research, we believe the other activist shareholder, Elliott Management, is familiar with GEA's new CEO, Stefan Klebert, through a previous investment, and we believe greater activist involvement should lead to more aggressive restructuring efforts.

GEA's share price is heavily discounted due to existing management's lack of credibility, primarily on pricing and expense management. GEA runs a fragmented operation, and current management seems unable to consolidate costs and, importantly, pricing strategies across product groups. Our fair value estimate of EUR 45 per share is well above consensus valuation, we think primarily on differences regarding margins and valuation approach. Consensus valuation has come down from around EUR 42 per share a year ago to about EUR 32 currently. In the meantime, the company's revenue growth has picked nicely to around 4%, but margins continue to disappoint. A valuation based on a 2019 enterprise value/EBITDA multiple would lead to a material valuation difference versus our discounted cash flow approach, where we factor in margins coming back from the bottom, gaining 240 basis points in the medium term.

Our confidence in the margin rebound comes from look at peer equivalents with similar businesses but much smaller manufacturing footprints and greater low-cost country sourcing. GEA's new CEO, who will officially take the reins in February 2019, has experience in downsizing a German workforce and significantly consolidating a manufacturing footprint.

In his previous role as CEO of Schuler, Klebert executed restructuring program over 2013-16 that included a 9% reduction in its Germany-based workforce over two years with a 200-basis-point EBITDA margin expansion. The manufacturing footprint was reduced to four from seven sites. According to our calculations, returns on invested capital held pretty steady at around 13%-15% during his tenure.

Klebert is not unknown to Elliott Management. He spent almost eight years as CEO of Schuler, and early in his tenure Elliott became a 10% shareholder in order to push for a higher bid from acquirer Andritz, which took control of Schuler.

GEA's medium-term restructuring includes 150-250 basis points of EBITDA margin expansion to 2022. Of this, roughly one fifth to one fourth is expected to come from footprint consolidation and roughly the same from procurement and efficiency. The rest will come from price increases and volume. Pricing improvement should come from better management of pricing strategies, which has been done a cost-plus basis and also product group basis.