New position in KSB: Pumps & Valves a cheap company in an attractive industry

KSB is a leading producer of pumps & valves. It was founded in 1871 in Germany, sells & services globally, p/e of 7.4 and has a highly valued Indian subsidiary.

KSB is a German pump manufacturer, family controlled & with a global reach. The company has a strong balance sheet and trades at 7.4 times earnings. Operational performance has been greatly improved, but I think further margin expansion is likely.
I found the company by reading Ennismore great monthly newsletter.
There is also good coverage on Value Investors Club.

Why I like the stock:

• Fragmented industry ready for consolidation.

• KSB has strong positions in water, industrial & energy sectors that are likely to grow in the coming years.

• Pumps are usually a small piece in a large system & mission critical.

• Serving more of its own pumps will lead to higher margins.

• Attractive valuation at 7.4 times earnings & good potential of high shareholder returns.

• Strong balance sheet with 340M is cash, no debt and 492M in pension deficit.

• Highly valued Indian subsidiary.

Fragmented industry

The pump industry is highly fragmented with the 10 largest manufacturers taking a 48% share. KSB is the number 4 with 5%. Given the highly specialized nature of the business means that there are a lot of niches. Over time though I expect the share of leaders to grow.

KSB positions

KSB has strong position in attractive markets like water, Energy & mining.

Their specialty knowledge in pumps for the nuclear industry might be especially of interest. This segment is still small but could grow quickly and is likely to have superior margins given the technical requirements.

Small mission critical piece

Pumps are always a relatively small mission critical part in bigger systems. This means that other things than just price become important. It is critical for pumps to be reliable. Delivering quality combined with service allows you to charge a higher price and make good returns on capital.

More service means higher margins

Historically KSB has not been great in capturing high returns. This has been shifting though since 2019. The company has been focusing more on the service part of the business. Still the company only services 20% of the installed base.

Getting this to 40% does not seem unreasonable. Pumps become more advanced and digitally connected. Being the manufacturer means that you advantage in servicing your own pumps will increase accordingly.

This will allow KSB to increase the margins further to 10% in 2030. This does not sound aggressive to me but will still deliver great shareholder returns.

High shareholder returns

In 2023 KSB delivered again better operating results leading to a net profit of 177M euros.

KSB has consistently improved results. This however has been done in such a manner that I don’t think this is part of a cyclical bubble. The results of 2023 and Q1 2024 are a testament to this. Many industrial companies have disappointed investors. KSB shows higher profits and is rewarded with a price earnings ratio of 7.4. I do think that the current level of profitability is sustainable and can even be increased.

Shareholder returns come from growth & dividends.

growth:
3% inflation
sector: GDP + 1% = 3%
Investments done by KSB through retained earnings to take share: +2%
Margin expansion by growing KSB SuperServ segment: margin from 7.9% to >10% in 2030. Leads to +4% annually.
Together = 12%
Dividend of 4%

Total return including dividend = 16% return

No special dividend, revaluation, sale of Indian activities or special actions necessary to achieve a great long-term return.

Conservative balance sheet

As most German family owned Mittelstand companies KSB has a conservative balance sheet. The company has no debt 340M euros in cash & 492M in pension deficit.

Equity at 1.2B euros (not included 770M for Indian activities) is higher that the 1.15B market cap. This is a shitco price for a quality business. A strong balance sheet will allow KSB to keep investing in a crisis & win market share while competitors are desperate to save the company.

German company with global reach

Investors are not very positive on Europe. While I do not share this gloomy outlook, KSB is globally diversified.

51% of sales come from Europe, company sees opportunities to grow especially in the US. This is both a risk (expensive acquisitions) as an opportunity (Profitable organic growth).

India is another gem worthy of attention.

India

India has a fast-growing economy and an expensive stock market. Getting exposure to this growth is nice, but I’m not willing to pay the multiples for it. Well-known companies with large listed Indian subsidiaries are:

British American Tabacco: (55B GBP) with its stake (now 25.5% was 29%) in ITC 5.65T rupiah (52.9B GBP for 100%, 13.5B GBP for 25.5%). 25% of market cap.

Unilever: (109B GBP) with its 60% stake in Hindustan Unilever 6.1T rupiah (57B for 100%, 34.2B GBP for 60%). 31% of market cap.

KSB has an even better proposition. The Indian subsidiary KSB Limited is highly valued on the Indian stock market at 172.55B rupiah (1.9B euros). KSB holds 40.54% share which is worth 770M euros. Market cap of KSB is 1.15B so stake in Indian Subsidiary good for 10% of revenue is 67% of market cap. The value of KSB Limited is 57M euros on the balance sheet.

Not sure if KSB Limited is worth 81 times earnings (I would not pay it), but it shows the market is quite optimistic about the growth prospects. Having in included in the total package is a nice bonus for shareholders though.

KSB Q1 2024

Good results of 2023 are not disappearing in 2024. Order intake was higher than revenue and the company saw further margin expansion.

What was also good to see was that free cash flow picked up strongly. I’m a strong advocate of looking at both the income & the cash flow statement to value and understand a company. A quarter without much cash flow does not say much, but long-term trends in cash flow conversion are important to me.

New position

In my H1 2024 overview I briefly touched upon my new KSB position. Doing more some more research convinced me to buy some more KSB very recently. This makes it a decent sized position in my portfolio.

Conclusion

KSB is a family-controlled business with a conservative balance sheet. Historically operational returns have not been great. This is changing. Results have improved but the market does not give the company any credits resulting in a price earnings ratio of 7.4. This is in my view unlikely to persist if margins keep increasing. In the meantime, shareholders are rewarded with a growing 4% dividend.

Disclaimer: These are my ideas and not personal investment advice. I might own shares discussed and can sell those shares at all times. I don’t know your financial situation. Do your due diligence and do not blindly follow an article on the internet.