Novem Group (NVM)
An automotive cash cow is revealed after a low-profile IPO and subsequent price decline.
Business.
The German Novem Group is the world’s leading supplier of high-end decorative interior parts for SUVs and premium cars, with a market share of 46%, double that of the nearest competitor. The firm went public in July 2021 with a small primary offer of 3.0m shares that raised €50.0m in gross proceeds and a private placement of 15.0m shares worth €247.2m. Whilst the initial offering price was €16.5, the market value has more than halved since then, making the shares very attractive indeed.
Novem’s product portfolio is high-quality and broad. Its trim elements are installed in the door areas, center consoles, or dashboards of premium cars and SUVs, with special parts like roof handles and trim backrests also on offer.
Trim elements are often sold in sets of 4 to 15, depending on the specifications of the OEM, and the Group seeks to upgrade the value of individual parts by adding features like backlighting, embedded sensors, and on-demand switches. The most common material for Novem’s trim elements is wood (3/4), with aluminum next up (1/5), and synthetic materials last (1/10 of sales). Carbon is not mentioned because it is used primarily for the interior trims of low volume, high-end sports cars. In FY2021, the Group supplied 4.2m trim sets for more than 100 platforms (e.g., BMW’s 7-series) for a total of 26.8m individual elements.
However, these significant volumes obscure the highly technical and intricate manufacturing process required. Just consider the complex task of shaping wood, a natural product with various inherent properties, to the exact specifications of an OEM without imperfections. Novem achieves this with high-tech, expert-operated equipment. Production can take 10 to 15 steps in most cases but up to 35 in others, and the common timespan from production to shipment is about 10-18 days (more information on this process is available in the prospectus).
Special tools are required to manufacture the trim elements. OEM customers require Novem to purchase these after an awarded contract but prior to the start of production of the relevant platform. Customers retain ownership of the tools but reimburse Novem upon confirmation of product quality and the start of platform production. This reimbursement takes the form of either a lump sum or over time surcharges for each trim element delivered.
Novem’s customers include almost all OEMs active in the premium vehicle space, like Porsche, Audi, BMW, Nissan, Ford, and Daimler (now Mercedes-Benz). These relationships are strong and long-standing. For example, Novem has a six-decade relationship with BMW, its first customer, and a four-decade partnership with Mercedes-Benz. The three largest customers - though unnamed - represented 39%, 30%, and 7% of sales in FY2021. The number of platforms supplied equaled circa 30, 15, and 10, respectively. These statistics do point to a very heavy dependence on the top three customers. But I think this risk is strongly mitigated (see risks section).
Novem’s typical production cycle is described below:
A request or quote is received from the customer. If determined feasible, the engineering team develops a tooling concept, obtains supplier quotes, and does a logistics calculation. The quote is then prepared or released back to the customer.
If nominated to proceed, design and development staff work with the OEM to develop a suitable concept. Revisions are often required as OEMs update their designs several times until a freeze 6 months prior to production. Also in this phase, suppliers are selected, purchase orders are made, and logistics, manufacturing, and quality measurement are planned.
The special tools required are tested and installed, and production of the trim begins. The preparation and refinement of next steps occurs in parallel.
Contracts are finalized, design specifications are set, and production tests are run to improve quality and efficiency of processes until the desired run-rate and ramp-up budget is met. Production is then ramped and products are delivered to customers. Fabrication KPIs are monitored throughout and assistance to customers is offered.
Thesis Points.
Novem is the clear leader in an oligopolistic market with good growth prospects. The overall premium decorative interior trim market (PDIT) has grown at a CAGR of 6.6% between 2016-2020, and is forecast to grow at 4.6% to 2026, producing an end TAM of €1.4bn. Europe is the largest market region, with a 40 to 45% contribution. North America is next at 35-40%, and Asia, primarily China, makes the smallest market contribution, at 30%. Growth drivers across these regions are premiumization, increasing SUV and premium vehicle production volumes, and a rising value of trim elements per vehicle.
Novem has a 46% share of the PDIT market. This is more than twice the share of the next competitor, JoysonQuin, which holds 18% and was acquired by China-based Guangdong Sensun Weighing Apparatus Group in 2020. Third in rank is NBHX, which holds 15%. Despite its smaller share, NBHX is the fiercest competitor because it offers trim elements made of all materials - JoysonQuin does not - and has a comparable global footprint. All other market participants are estimated to hold market shares of 10% or less. The fact that these three peers hold almost 80% of the market points to significant pricing power.
High-quality trim elements are very important to Novem’s customers. There are two reasons for this. First, what is important to the vehicle buyer is important to the OEM. A purchaser of a premium car expects a differentiated premium look and feel. This is true for the interior in particular as this is where the more subtle manufacturing qualities come to the surface (the classic shake and knock test of the dashboard or console comes to mind. Or is that specific to Germans?). Second, customization of the car interior is a high-margin profit tool for the OEMs, which have relatively low margins to begin with. The critical importance of interior trim to OEMs combined with an oligopolistic market grants Novem significant negotiating power when it receives tender offers. Indeed, the firm estimates a 48% wallet share for its top three customers in FY2020 i.e., sales as a % of customers’ overall premium interior trim purchase volume.
Novem’s experienced personnel are deeply embedded in the OEMs. Novem’s designers, technicians, and engineers, some of whom work on-site at specific OEM’s plants, are often integrated into the early pre-development phase of a platform an entire 4 years prior to production, with contracts being awarded either 2 or 3 years prior, and close cooperation continuing until the design freeze and finalisation 6 months before launch. This integration, combined with simultaneous work on several platforms in different stages for each OEM customer, produces strong revenue visibility. In fact, Novem has a backlog of €4.5bn, which is 7.3x 2022 sales of €615m.
It could also be argued that this integration creates switching costs for customers. Large OEMs have but a narrow choice of suppliers to begin with, and selecting a new one would require designers, engineers, and technicians to be trained up on current and future platforms in addition to a significant reconfiguration of interconnected supply chains. I cannot imagine this headache being worth it unless there is a very good reason. The alignment of Novem’s capabilities with OEM’s vehicle development and long-term strategic plans also strengthens customer relationships.
Novem benefits from scale effects and boasts operational excellence in a complex manufacturing niche. The Group operates 8 manufacturing facilities across Europe, Asia, and the Americas (4 owned, 4 leased), and 2 assembly facilities in the U.S. (both leased) with 5,600 FTEs. These factories are well-invested, with the largest also being the newest, and maintenance capex being equal to a mere 2% of sales. This global scale permits better supply chain management and lower tooling costs, which translates into more attractive pricing for customers (read market share maintenance or expansion).
The nature of the premium trim element fabrication process also demands significant know-how and experience, insulating incumbents, and Novem excels here. It has the lowest scrap rates in its industry - a differentiating, major driver of profitability - and continues to seek out and realize operational efficiencies, like increasing production speed to achieve shorter lead times.
For those with macroeconomic concerns, Novem has shown a degree of resilience to recessions in the past. During the great financial crisis, Novem’s sales fell a mere 10% between 2008-2009 and 8% in the 2009-2010 period. The Group remained EBITDA positive throughout, and saw a full rebound of sales by 2011. The current backlog of €4.5bn and fact that 76% of costs are variable - and therefore fall when sales decline - is also reassuring.
Valuation.
Based on the low growth, stalwart nature of Novem’s business, I used a conservative earnings power valuation (Bruce Greenwald’s method). The assumptions and outputs are shown below.
Novem can also be compared to its fiercest rival, Ningbo Huaxiang Electronic Co. (NHBX), on the basis of forward EV/EBITDA multiples (forward EV/Sales are too similar). NBHX trades at 5.1x NTM EV/EBITDA premium compared to 3.6x for Novem. To reflect the same multiple, Novem’s share price would have to rise to €11.5.
But this is a pure intellectual exercise because one multiple and one peer make for a poor relative valuation and the enterprise value bridge is assumed to remain the same. Moreover, Novem is significantly more profitable and earns higher returns on assets than NBHX, as seen below, which suggests that a substantial premium to NBHX would be warranted.
I think Novem could double from here, and the forward dividend of 8% is great compensation for the wait.
Risks.
I think the greatest risk with this investment is the loss of a customer, as 76% of sales come from the top three. But certain factors mitigate this risk:
Relationships in this industrial niche are long-standing, cooperative, and integrated.
Customers have little choice in an oligopolistic market and face switching costs. Novem’s main rivals are also Chinese companies, which could be a less desirable option for OEMs for various reasons.
As to the balance sheet, Novem secured a €310m debt agreement at IPO, which consists of a €250m term loan and €60m credit revolver. 100% of the term loan has now been drawn, with €5.8m due in the next 12 months. The RCF remains untapped, and there is €113.5m in cash and equivalents on the balance sheet. This is a manageable debt position, for sure, with about €76m in annual free cash flow on top.
There is some single shareholder risk because COHV AG, an investment firm, owns 78% of outstanding shares. Actions that COHV AG takes might benefit itself more than other shareholders.
Other.
Management’s stake in the firm is negligible at around 1%. Compensation consists of a base salary, short-term incentive (70% EBIT, 30% free cash flow), and long-term performance share plan (70% TSR, 30% EBIT margin). Target compensation for the CEO, Günter Brenner, is as follows:
Base €850k.
STI €250k.
LTI €375k.
I think the share price decline could be due to widespread fears about the energy security of German industrial companies.
Novem Group is covered by four analysts with a mean target of €15.7.
Disclaimer: this write-up describes the author’s own research and opinions, and does not constitute investment advice, whether explicit or implied. Invest at your own risk and do your own due diligence. I hold a material position in the issuer’s securities.
Good job! Thanks for the read.
What's your opinion about delivering 99% FY23 net income as dividends? This decision was followed by the CEO step down. Maybe a coincidence.
I think COHV AG (Brenninkmeijer Family, bregal.de) has a lot to do with these decisions.
The company has been decapitalized without reducing debt, but they still have reasonable leverage.
Do you know who owns Novem's debt? I was not able to answer this question.