EUR 850.00 For Business Accounts Only

Morningstar | GEA Announces Full-Year Results and High Level Steps for Restructuring; Shares Undervalued

We are maintaining our wide moat rating for GEA Group. While the shares rallied on the back of high level restructuring measures announced by new management, GEA still trades at a deep discount to our fair value estimate, negative 38% relative to our EUR 38 fair value estimate, and below 2 times book value.

Details behind the high level comments won't come until September's capital markets day, but nearly all the initiatives are in line with low hanging fruit that we've highlighted in our notes and reports. We think the greatest valuation impact will come from 1) restructuring the solutions business (i.e., project engineering) and 2) moving the manufacturing footprint to low cost countries.

Management let go of the head of its solutions business, a telling first step. The margin volatility and guidance misses over the past couple of years have come from the solutions side, which is priced on a project-by-project basis. On the other hand, in equipment (50% of revenue) margins have been fairly steady over the years, quantitative evidence of its bargaining power with customers. First-quarter 2018 at 8.6% was exceptional with an 18% move in EUR vs USD in first-half 2018 hurting margins as GEA has a sizable manufacturing footprint in Europe. We think the company lost a level of oversight into project pricing when moving the finance functions from local level management to a more centralized model. Other industrial companies have had to implement selectivity programs for project pricing for examples. We see this as fixable issue for GEA, although it will take time.

New management reiterated the target of previous management of addressing the disproportionate exposure of its manufacturing footprint to high cost developed countries. More than 80% of the company's production takes place in Europe, where it only generates 36% of revenue. We see this as an executable area. Poland, for example, offers excellent logistics connections with Germany and lower costs.

Other initiatives include increasing bargaining power with suppliers by using a smaller number of counter-parties, i.e., pooling the company's orders to get volume discounts, investing in more IT staff to help address the ERP and other systems issues from integrating tens of platforms, including nearly 100 ERP systems. Management indicated that it could divest of some weaker areas of the portfolio, which we guess could be commoditized areas of equipment--bottling might be one area.

Management guidance now includes the introduction of a return target, ROCE with 2019 at 8.5% to 10.5%, which we applaud. We note this figure includes goodwill from Metalgesellschaft's (MG) 1999 acquisition of GEA. We do not count this goodwill in our ROIC calculation, as this was a one-time event with assets of the purchasing company, MG, long ago full divested. Excluding the MG goodwill adds 500 to 600 basis points to ROIC, which well exceeds the company's cost of capital based on our 8% WACC assumption.