Finland’s Kone under the microscope after solid China growth

Edited by Martin O’Rourke

Finnish elevator-equipment company Kone Corporation has established a strong first-mover advantage and is a solid market leader in China which has the fastest growing real-estate market in the world. China’s urban population has grown at a 3.6 percent compounded annual rate since 2002, or 21 million people per year. And the urban population has risen to 691 million in 2011 from 502 million in 2002.

Consequently, 7 million new households are formed each year in China via the urbanisation process. Not surprisingly, China has been the main driver behind Kone’s revenue growth with sales currently representing 30 percent of total revenues for Kone. Kone has also outperformed many of its competitors with market share for new installations in China rising to 17 percent in 2012 from 10 percent in 2009.

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China’s remarkable urbanisation push has afforded Finnish elevator company Kone tremendous growth opportunities. Photo: Shutterstock

Kone’s also demonstrates a remarkable operating efficiency with one of the highest capital rotation and inventory turns in its industry. Kone’s ROIC, which measures how much economic value a firm yields, shows stable figures of 50-60 percent in the last five years which we consider high. In addition to this, Kone also has low default-risk on long-term debt with less than 2 percent debt outstanding. We can definitely conclude that Kone is a well-run company with a favourable market position.

It is only the valuation that becomes problematic. With a current share price of EUR 63.30 EUR, PE above 25 and PB close to 10, Kone is one of the most overvalued companies in a sector with excess of inflated ratios.

The high ratios for Kone may be justified with assumptions of continued high growth rates but signals of a decline are convincing. That was confirmed by its third-quarter release on Tuesday in which revenue growth predictions for 2013 averaged around 12 percent, down from 2012’s remarkable growth of 20.1 percent.

Kone seems to have reached its limit in revenue growth and thus we expect lower growth rates over the coming years. This is not only attributable to slower growth predictions for China with the construction market down 18 percent this year but also to a deeply gloomy prognosis in the southern Europe market where the construction market has plunged almost 70 percent from 2007-levels, according to a report by J.P. Morgan.

Set that also against the decision in the US to postpone the debt ceiling battle to the early part of 2014 with its far-reaching potential to disrupt markets, then the context within which Kone is operating is altogether a somewhat muddled one.

The fundamental analysis also shows an intrinsic value far below the current stock price and even when we apply less conservative growth estimations, it becomes hard to justify Kone’s current price. Our estimated fair value price from a discounted cash flow analysis is EUR 52, representing a downside of 18 percent. We believe the high price is partly due to an overall optimistic market and partly attributable to Kone’s solid historical growth, operating efficiency and market position but that fails to take into account the lower growth prospects ahead.

With that said, a unanimous panel decided to not enter Kone at this point. However, Kone will be on our watch list and may become attractive at lower price intervals.


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