European small and mid caps-Stock picks Q4 2007-Q1 2008 - Fourlis

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Mid cap European small and mid caps 17 October 2007 abc Deutz Strong Q2 top-line momentum and substantial EBIT margin improvement in Compact Engines, despite ongoing production bottlenecks We expect stress factors to fully disappear in H2 2007 and a return to the fore of the structural growth story - driven by OEM outsourcing 10% premium for far above-average CAGR 2007-09e of 17%, vs 7% in our German Engineering universe. Overweight rating and EUR11.0 target price remain unchanged Investment summary Top-line CAGR 2007-09e of 17% Q2 2007 results support our view that margin pressure, resulting from production bottlenecks is a temporary issue. We continue to believe that the structural growth story, which is driven by an OEM outsourcing trend on the back of steadily tightening emission thresholds, should again come to the fore. The recent disposal at an attractive price of the Power Systems division - which lacked synergies with the rapidly growing Compact Engines division - has further sharpened the company’s short-to-mid-term growth profile and also creates the financial scope to sufficiently exploit the considerable long term growth potential of compact engines. We now expect a 2007-09 CAGR of 17% (10% before), far above the 4% average of the relevant market, above all driven by increasing captive production volumes. Underlying EBIT margin improving Q2 saw strong momentum in the remaining Compact Engines division (eg sales +43% y-o-y, EBIT +26%) and a substantial improvement of the EBIT margin, from 4% in Q1 2007 to 6%, despite ongoing production bottlenecks, which emerged in Q4 2006, due to much stronger-than-expected demand (Q2 margin >7% if adjusted for the bottleneck impact). Key facts ____________________Financial summary _____________________ __________ Valuation summary ___________ Analyst: Juergen Siebrecht Year to Revenue EBITDA HSBC HSBC HSBC Yield HSBC EV/ EV/ IC ROIC HSBC Tel: +49 211 910 3350 (EURm) (EURm) net profit EPS EPS growth (%) PE EBITDA (x) (%) REP Email: juergen.siebrecht@hsbc.de (EURm) (EUR) (%) (x) (x) (x) Current price (EUR) 9.4 12/2006 1,490.0 154.1 60.9 0.51 220.5 0.0 18.3 9.2 2.0 11.3 1.6 Target price (EUR) 11.0 12/2007e 1,550.0 161.7 68.5 0.58 12.5 1.4 16.3 6.3 1.8 12.9 1.2 Mkt cap (EURm) 1,105.0 12/2008e 1,749.0 191.2 89.8 0.76 31.0 2.0 12.4 5.3 1.6 16.7 0.8 Bloomberg DEZ GR 12/2009e 1,840.6 202.4 100.1 0.85 11.5 2.1 11.1 4.9 1.4 15.7 0.8 Reuters DEZG.DE Source: company data, HSBC estimates 28
Mid cap European small and mid caps 17 October 2007 abc DEUTZ organisational structure DEUTZ Compact Compact Engines Engines • •Oiland Air-, oil-, water- and water-cooled engines engines with outputs with outputs of up of to up 500kW to 500kW for on-road and off non-road applications • Tailor made solutions for customers • DEUTZ Customised solutions Deutz Deutz Customised Power Systems Solutions • Engines, • Air-cooled gensets engines and systems with outputs of up to 4.0 MW Used • Water-cooled to convert engines renewable above and 8 fossil litres fuels cylinder capacity • Project-related • Other, non-engine systems activities business (eg special that involves generator/sets) high degree of engineering Source: DEUTZ While Deutz lowered its 2007 EBIT margin target from around 7% to more than 6% at Q2, it substantially increased its 2007 top-line target from 10% to 20-25%, implying a substantial increase in the Compact Engines top-line expectation to +30% y-o-y. We expect a solid H2 2007 Compact Engines performance, driven by ongoing high volume growth (HSBCe Compact Engines sales H2 +27% y-o-y) and even higher EBIT growth (HSBCe Compact Engines H2 EBIT +70%). This is driven by a normalisation of component supply, on the back of conducted capacity expansions and further price increases, both indicated at Q2, as well as on ongoing cost optimisation progress. We expect the company to meet its 2007 EBIT margin target of more than c6% (HSBCe 6.3%) and see further EBIT margin expansion in 2008 (we estimate c7% in 2008, up from a one-off adjusted 5.5% in 2006) as: (1) the two largest compact engines outsourcing agreements should be fully ramped up by then and in the meantime, capacity problems, which caused margin pressure in 2007, should be resolved. Second, the company should be able to profit from a broad range of engine innovations released over the last two years and from a relative low level of R&D spending (with no new emission thresholds requiring major engine development efforts). Valuation not fully reflecting growth Given an expected 2007-09 CAGR of 17% for Deutz, substantially above the 7%, that we expect for our German Small & Mid-Cap Engineering universe on the one hand, and average EBIT margins 2007-09 in line with the sector, on the other, we allow for a 10% valuation premium, which leaves us with a target price of EUR11.0 and an Overweight rating. Deutz: sales by division (FY 2007e) Deutz: sales by region (FY 2007e) Customised Solutions 18% Compact Engines 82% Other European 43% Middle East 4% Africa 3% Germany 27% America 14% Asia/Pacific 9% Source: HSBC estimates Source: HSBC estimates 29
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European small and mid caps-Stock picks Q4 2007-Q1 2008 - Fourlis

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