Pfleiderer - The nature of its arbitrage - Positioning

All,

Please find our almost entirely new analysis of Pfleiderer here.

Along with KemOne, Pfleiderer lines up as one of those real estate derivative companies that are finding themselves cyclically unprofitable in this economy. Similar to KemOne’s recent refinancing, Pfleiderer’s effort suddenly looks a little short-sighted and the market seems to agree. Our renewed analysis reveals a far steeper downside if the first two quarters of stabilisation we have been clinging to turn out to be just that - stabilisation at far too low volumes. 

Investment Rationale:

- We are selling our 5.5% long position in Pfleiderer’s 4.75% 29s. The bonds dropped 10 points to a 75.5c/€ bid in the recent sell-off, but that may have been for the right reasons, considering the potential impact of US tariffs on Germany. Pfleiderer seem to be stabilising here, but it's early to make that call and the company really needs to turn around and substantially grow volumes to pay for its interest. 

- Liquidity is adequate following the A&E, but without volume growth, Pfleiderer should still run into problems as soon as a year from now. The recent A&E transaction may not have injected sufficient liquidity to nurse the business through a prolonged market weakness that may result from uncertain geo politics, German elections and general economic headwinds befalling especially its auto industry - with or without US tariffs (and so far still with).

- Without a timely turnaround, the downside is 60c/€ if adding €100m of fresh cash and much of that recovery would have to be in the form of equity.

- There are no other triggers, but unless we learn of a strong turnaround on the call later this month, we will be selling the second half of the position thereafter.

Elasticity and Pass-Throughs:

- Pfleiderer is an arbitrage between volatile commodity inputs on the one hand and a highly cyclical downstream construction sector on the other. The fluctuation of its raw material prices translates into demand volume only with a year's delay or more, but it is by no means the only driver. So the company can spend long periods deeply in or out of the money with little that management can do to make ends meet, other than finance the company very prudently - and that it has not done.

- Pfleiderer has tight pass-through arrangements on its input costs for good reason. Demand from the DACH construction and refurbishment industry is highly elastic, as there are more cost-efficient alternatives to wood panels. Gross Margin remains relatively constant through the cycle (due to the pass-through contracts). But low volume cannot carry the fixed costs in the business.

- On the way down, volumes fall approx. a year after prices rise and at least at the same pace. Projects are planned and sold with specs that still need to be fulfilled to completion. 

- On the way up the delay can be longer and the correlation not as tight. In reality, while it looks as if prices are leading volumes, it is mostly the other way around. 

DCF vs. Sum Of The Parts:

- In the current economic and geopolitical environment around the DACH region, we see no reason to model a quick turnaround in demand from construction and big-ticket refurbishment. Please call us if you disagree.

- Without that turnaround, however, the DCF remains as negative as the free cash flow. The upshot is that debt-carrying capacity could be a theoretical concept if stakeholders must gather for another conversation in the not-too-distant future.

- Breaking up the company helps. Pfleiderer are attaching positive IFRS 16 EBITDA to Silekol, and a not-too-aggressive multiple should provide €200m of value. A distressed multiple on the German division of 5x (giving full benefit to all EBITDA adjustments) yields another €315m of value.

- Together, the sum-of-the-parts valuation less €100m for fresh cash (ignoring the €60m securitisation), which will be needed if the analysis is needed, arrives at a recovery of a mere 67c/€. Arguably we are only trading 10 points above that, but most of those 67c/€ will be equity and the bonds would be trading accordingly. Pfleiderer has been there before.

Here to discuss with you,

Wolfgang

E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk