MATELAN Research - ISRA VISION AG

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ISRA VISION In-Depth Report Leveraging strong market positions and driving growth with new product initiatives Double-digit net profit growth based on conservative top-line and margin assumptions Further progress in NWC could unlock additional value – positive free cash flows from coming year onwards Q3 follows up on strong Q2 numbers – doubledigit growth also expected for next year Conservatively calculated fair value of EUR23.6 CCA and CTA point at further headroom. - 4 - metal with shares of 80% and 65%, respectively. This makes it hard for the customer to find acceptable alternatives. ISRA is clearly differentiating itself from the competition through is global presence, its broad product range and technological leadership in many areas. Moreover, the company is currently undertaking some initiatives to fuel further growth in the industrial automation segment with new product launches and we expect the company to continue its successful strategic expansion in the surface vision segment. Based on the positive developments that ISRA is currently experiencing as a result of improving market dynamics as well as the company’s strong position in its relevant markets, our current growth assumption of 8.6% over the medium-term appears rather conservative and takes into account a potential economic slowdown. In particular, we have not yet priced-in management’s target of more than EUR100m in sales in the coming years. We also assume only a slight margin increase. Still, net profit growth comes to a CAGR of 15.2%, which means a doubling over the coming 5 years. One of the key financial drivers – apart from earnings development – is working capital. ISRA clearly has above-average working capital needs and improvements on this side could unlock substantial value for the company. Against the background of its low capital intensity, ISRA is still earning its cost of capital and shows an industry average RoCE, when excluding goodwill. Despite the financing of numerous acquisitions, ISRA still shows a low gearing. Although the company is likely to further consolidate the market, we are not pricing-in any acquisitions. This leaves the company in a position to produce positive free cash flows from the current year onwards. The third quarter sustained the strong picture presented in the second quarter, leaving our full year estimates too conservative. We have thus raised our esitmates without becoming aggressive. Order intake accelerated further and led to a further increase in the order book. A quarter of our sales forecast for the coming year is already in the books and we expect this to double by year-end. Against this background, management has not only reiterated its guidance for the current year, it also expects double-digit growth in the coming year, even in view of the current uncertainties regarding the macroeconomic environment. We value ISRA’s stock on the back of the financials described above. Our DCF analysis arrives at a fair value of EUR23.6 when sticking to the conservative approach that we had already used in estimating the company’s financials and employing an increased market risk premium to reflect current uncertainties on equity markets. A normalization of the risk perception would even drive this value to EUR26.5. Our peer group analysis shows that ISRA trades at a significant discount to the average multiples of its peers, in particular on a PE basis. Implicit multiples on the base of our fair value bring ISRA’s PE in line with the average of its closest peers. Applying average multiples of all peers to ISRA’s earnings yields values in the range of EUR20.8 to EUR30.2. Moreover, ISRA trades at PE discounts of 14.8% and 9.8% to the Elexis transaction even based on our valuation before the risk adjustment. Our conservative DCF valuation thus not only gives the share an upside of 35%, the comparable company analysis as well as the comparable transaction analysis supports the view that there is still further headroom in our valuation.
ISRA VISION In-Depth Report VALUATION DCF and peer group valuation Three stage DCF model Conservative long-term assumptions for growth, margins … … and WACC calculation Fair value of EUR23.6 - 5 - For valuation purposes, we use a detailed DCF model and a peer group comparison based on the most important valuation multiples. While the DCF model is our main valuation tool, which allows for an in-depth discussion of ISRA’s most important value drivers, the peer group comparison is used as a validity check for our results. Our DCF model calculates ISRA’s fair value by discounting the company’s future free cash flows. In the first phase, we derive the free cash flows from our detailed financial modelling, which is discussed in the financial section of this report. The cash flows are then estimated via linearization of all important value drivers to a normalized value. From the latter, the terminal value is calculated. As the terminal value assumptions in particular have a large impact on the valuation, we have kept them conservative: We have, for example, set the growth rate of total output to 1.5%, which is merely reflecting inflation. We thus assume no real growth in ISRA’s total output in the terminal value. To underline this, we have equated the depreciation rate with the rate of investment, meaning that the company is only replacing its capital invested in the business and not expanding it. In addition, we have set the EBITDA margin slightly below its value in the last explicitly estimated period (i.e. 2014/15). Moreover, we have not assumed any further improvements in ISRA’s working capital in the terminal value. All free cash-flows are discounted with the company’s weighted average cost of capital. This is based on the current forward rates of German government bonds as risk-free rates. To determine the cost of debt, we add the credit spread and adjust the tax shield. On the equity side, we add a market risk premium, which is weighted with a beta factor. In order to reflect current uncertainties with regard to the economic development in 2012, which is documented in the recent sell-off on equity markets, we have raised the market risk premium for small caps by 1pp to now 7%. The beta factor is derived fundamentally, taking into account the company’s risk profile as summarized below. In the case of ISRA, we see a higher risk compared to the market in all risk categories, which results in a final beta factor of 1.2. Weighting the cost of equity and debt with the market values of the company’s equity and debt, we come to WACCs between 7.5% and 11.4% for the years under review. All assumptions of our valuation are detailed in the table below and result in a fair value of EUR23.6, which provides the share with an upside of roughly 35% to the current price. It should be highlighted that under the same set of assumptions our fair value would come to EUR26.5 if we had not raised the market risk premium. This represents an additional upside if equity markets start to normalise and ISRA delivers on the expected earnings streams.
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MATELAN Research - ISRA VISION AG

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