KME – disposal reports and valuation coverage
All,
Please find our unchanged recent analysis on KME here.
Heightened speculation around a potential disposal of parts of the Special products division, triggered by a Reorg article, has led to a further appreciation of the KME bonds.
This supports our thesis that the underlying characteristics of the KME’s business would justify an EV/EBITDA multiple more in line with specialty niche manufacturers such as specialty chemicals, which is to say pretty high, around at least 8-10x. We have a 5% long position on the bonds, which we maintain for now. As our initial target of high 80s has been reached, we will be considering it in light of the potential additional upside of the deal, the asset-backed facility extension, the potential government-backed loan, and the current market environment for yields in the stressed HY space.
As we elaborate in our analysis, KME has been resilient to both the significant autos slowdown of 2019 as well as the even larger 2020 Covid impact. In addition, its exposure to the electrification trade provides it with a structural tailwind going forward. Both factors are likely to support high multiples.
While M&A speculation surrounding KME’s Special division has been on and off for months, the new article highlights more concrete information, including the potential identity of the bidders – two PEs and one strategic player. It also highlights that the extension of the inventory-backed facility is in the final stages.
Part of the reaction of the bond prices may have to do with short covering. KME in the past has been the target of significant bond shorts, which peaked in 2019 but have remained an important factor ever since. Any short position in KME, especially in the current forgiving market environment, would need to be predicated on a short-term liquidity event. Which we see as very unlikely, as discussed in our analysis.
We are debating in the desk if this deal is driven by liquidity concerns or purely an opportunistic move by management. For an Italian family-owned company, selling a resilient asset such as Specialty would in principle be unusual. However, management has become increasingly aware of the lingering investor concerns about the sustainability of the capital structure at both the KME and Intek levels. The disposal should be highly accretive, given the market valuation of the whole of KME as a copper producer, as implied by the bond yields.
It is unclear how much of the Specialty division will be sold. According to some reports, it could even include virtually all of it. We estimate Specialty could be around 50% of EBITDA, despite producing only around 34% of revenues, because of its much higher margins. That would easily cover the existing EUR300m bond, at an EV/EBITDA multiple of around 10x or above. KME has spent the past few years trying to increase the product specialization of each of its plants, which in fact already enabled it to execute the Brass disposal before, so we believe a separation of Specialty would be doable.
Please feel free to reach out if you would like to exchange ideas on the name.
Juliano
___________________
E: jtorii@sarria.co.uk
T: +44 203 744 7055